44 report of. special study of securities...

44 REPORT OF. SPECIAL STUDY OF SECURITIES :MARKETS

Nevertheless, the practice of seeking or acceptin~ membership onan issuer’s board and making an over-the-counter tradi.ng market inits stock does exist in considerable degree. Tabulation of question-naire OTC-3 responses indicates that in the spring of 1965, some 508different broker-dealers, out of the total number of 4~96~=broker-dealersresponding to the questionnaire,s~ reported that they carr.ied on suchtrading activity in the stocks of one or more corporations while at thesame time represented on the issuer’s board by an officer, director,p, artner~ or employee,s7

Although some of these broker-dealers take the position that boardrepresentation is ~ssent.ial, or at least highly desirable, in performingthe functions of making a market, most do not go so far. ss Ratherthan considering one as tied to or necessitated by the other they wouldregard both ,as stemming from a common source, their r~le as nnder-writer. In other words, having underwritten an issue they assert adouble-barreled responsibility to provide a continuous market and toparticipate in management. These are briefly considered in turn.

Most firms asserting a responsibility to maintain a trading marketfor an underwritten issue recognize that obligation entirely apart fromthe question of board representation. It is a responsibility voluntar-ily assumed as a matter of business practice, as distinguished frombeing imposed by law or regulation~ and is thus subject to self-imposedlimitations or complete disavowal and abandonment when it provesinconvenient or burdensome. Nevertheless it is undoubtedly takenseriously by many firms, whatever they may consider to be the scope anddepth of the obligation in particular circumstances, s9 Dependingupon the responding broker-dealer, it has been described to theSpecial Study in various ways, including :* * * [requiring] that we "make a market," whenever a satisfactory marketoutside of our firm h.as not been developed by other dealers. * * *

* * * * * * *

We feel our responsibility * * * is continuous as an original underwriter tosee that a market is maintained. * * *

* * * * * * *

We feel a responsibility to maintain a reasonably good market in stocks ofcompanies where we have been a principal or managing underwriter. * * *

* * * * * * *

* * * we are prepared to commit more funds to the maintenance of an orderlymarket * * * [where] we were managing underwriters in the flotation of theseissues. * * *

* * * * * * *

In all cases where we have managed financings for companies whose securitiesare traded over the counter, we would feel it incumbent upon us to continueto make a market even though market conditions and other similar factors wereunfavorable, v~herects we would not feel it incumbent upon us to do so i.n othersituations. * * *

s¢ OTC-3 was sent to every broker-dealer in the country registered with the Commission.s7 It should noted that, under the holding of Blan v. Lehman, 368 U.S. 403 (1962),

unless an individual is "deputed" by his firm, trading profits of the firm are not affectedby application of sec. 16(b). Corrective legislation is recommended below.

ss Although there are obvious differences between stock exchange specialists and over-the-counter market makers, it might be noted that at least the New York Stock Ex-change and the American Stock Exchange both prohibit specialists from acting as di-rectors of issuers in whose stocks they specialize. Indeed, the former’s prohibition

,extends not only to the specialist but also to the partners or stockholders o~ the firm towhich he may belong, and any firm employee.

s~ See discussion at chs. III, IV, and VII.

REPORT OF SPECIAL STUDY OF SECURITIES !~ARKETS 45

Many such firms refer to their obligation to trade as simply re-quiring that they "make a market." 9o Others go further and call tl~em-selves a "sponsor" for the market of an underwritten stock. Whiletheir definitions of sponsorship differ, the emphasis seems to be oncontinuous performance of the function of market making rather thanon a special kind of performance.911 A typical description, by a lead-ing investment banking firm, is as fo lows:

We consider ourselves sponsors only of those unlisted securities of corpora-tions toward which we currently deem ourselves investment bankers and whoseofferings we have, as managing underwriters, publicly offered in which cases, wewill not withdraw from making a regular two-way market in the securities ofsuch corporations. It does not necessarily follow that in all such cases or atall times we make the primary ~narket.

The responsibility of serving on corporate boards of directors, andits advantages from several points of view, have also been defined invarying ways. Although many broker-dealers apparently see no suchresponsibility or need, either from the point of view of an underwrit-ing relationship or in relation t~ market making, thos~ who make apractice of obtaining board r~presentation are vigorous in its defense.As already indicated, they generally point for their reason to the un-derwriting relationship rather than the market making function assuch. However, some go further and seriously contend that they can-not, or find it quit~ difficult to, effectivelymake a market without thebenefit of board representation.

Typical of the statements received by the study which throw somelight on the interrelationship between the two functions are the fol-lowing:

* * * [We] feel a greater confidence in a corporation in which we are repre-sented by a director. Because of this confidence we are able to make a bettermarket,’ and by doing so render a public service. As a matter o~ fact, we wouldnot have agreed to be managing underwriters in a number of issues in which wehave acted in that capacity unless we had been assured of representation on theboard of the company in question, for the reason that having recommended--andsold--the company’s securities to many of our clients, we feel a anost definitemoral obligation to see to it that there is no conflict between the company ac-tivities and the legitimate interests of the stockholders. In other words, ourinterest in directorships is not financial, because the compensation is usuallyminimal and completely out of proportion to the time consumed, but rather, it isa "watchdog" interest * * *

We are more likely to continue "making a znarket" in those stocks in whicha partner or employee of our firm is a director than we are in the stocks in whichthis is not the case.

As you will note in our answers to previous questions, a much higher percent-age of those stocks in which a director is involved are sponsored stocks as co~n-pared to those issues in which no directorship is involved.

Where a partner or employee of our firm is a director of a corporation whosestock we trade, it is usually the result of a previous investment banker relation-ship with the company. For this reason, it is natural that our interest in thesubject company should be greater than otherwise, and that we should feel moreo~ a responsibility in the continuity of a market for its securities.

~o Questionnaire OTC-3 defined the term "make a market" as "enter a listing in thedaily ’sheets’ of the National Quotation Bureau and/or stand ready to buy or sell thestock ir~ limited quantity."

~ The Commission has defined sponsorship as "* * * [making] a continuous market inthe securities of a particular issuer regularly executing orders to buy or sell comingfrom other investors or other dealers" SEC, "Report on S. 2054," Senate Committee print,84th Cong., 2d sess., p. 12 (1956).

46 REPORT OF SPECIAL STUDY OF SECUR][TIES MARKETS

Without questioning the sincerity of motives in most cases, it mustbe pointed out that less altruistic motives are sometimes present, andpresumably even dominant. Board repesentation is admittedly soughtin some instances as the best assurance of future investment bankingbusiness, or purely for whatever prestige may be involved, and pre-sumably in still other instances as a source of advantage in tradingor retailing activities22

The possible consequences of terminating either ’board representa-tion or .marketmaking by reason of section’ 16(b) is further discussedbelow. The immediately following section identifies and describes thecharacteristics of issuers involved in the interrelationship, i.e., thosewhich might be directly affected by extention of section 16 (b) in thesens~ that a broker-dealer represented on their board and making amarket for their stock might feel compelled to discontinue one or theother activity.

a. The characteristics of issuers with inte’rloe~cing directo~-marlcet

In answer to question 15 of questionnaire OTC-3, which was sentto every registered broker-dealer in the country, responding broker-dealers listed all stock in which they made trading markets and at thesame time were represented on the board of the issuer. They alsoindicated those stocks on their lists of which they considered them-selves a "sponsor." Thus, the questionnaire responses showed sub-stantially every trading market being made a broker-dealer repre-sented on the board of the issuer in the country at the time, early 1962,whatever the degree of broker-dealer responsibility to the market byreason of responsibility to the issuer happened to be. It was possible,,moreover, to learn something about the nature of the group of issuersinvolved from the virtually contemporaneous questionnaire, OTC-4,in which a 1-in-5 random sample of issuers of stocks quoted in theJanuary 1962 monthly summary of the :National Quotation Bureauwere asked to supply certain information about themselves, includingcorporate size and securities activity data23 The two questionnairesthus made it possible, for the first time, to ascertain the extent towhich board representation and market making coincided and to studythe cha.racteristics of representative issuers involved.

From questionnaire OTC-3 it appears that the 508 broker-dealerswho made trading markets for stocks of corporations on whose boardsthey were represented did so, in the aggregate, for 1,610 stocks of1,4=81 different issuers. Three hundred and fifty-two of the 1,481 fellinto the OTC-4 sample and responded. A detailed presentation ofthe corporate characteristics of the 352 that were gleaned from OTC-4 is s~t forth in table IX-6; here only a summary analysis will begiven. The nature of the,OTC-4 sample, a random selection of issuerscharacterized by broker-dealer interest, provides strong probabilitythat the 352 are typical of all 1,4~81 issuers listed in the OTC-3 re-sponses as falling in the board-represented market-maker category.

Issuers with interlocking director-market maker relationships tendto be of moderate asset size, with 34.2 percent of the corporations in

~ See ch. III.F.~ OTC-4 issuers were asked to identify any of their officers or directors who were

associated with broker-dealer firms that maintained trading markets in the iss’uers’ stocks(OTC-4, ques¢ion 3). ~he definition of the term "made a market" was taken from OTC-3.See note 90, above.

REPORT OF SPECIAL STUDY OF SECURITIES MARKETS 47

the sample group reporting assets of between $1 million and $4,999,-999 and another 40.2 percent reporting assets of $5 million or greater.Their stocks tend to be held by substantial numbers of shareholderswith 85.2 percent of the issuers reporting 300 or more shareholders,67.8 percent reporting 500 or more, and 54.1 percent reporting 750 ormore. The director-market maker issues also tend to be rather ac-tively traded; 76.4 percent reported 200 or more transfers and 62 per-cent reported more than 500 during a 1-year period. Similarly, two-way quotations were listed in the National Monthly Stock Summaryedition at the close of the period October 1-I)ecember 31, 1961 by fiveor more dealers for 54.0 percent of the issuers. Finally, most exhibiteda marked degree of concentration of ownership. The 10 largest share-holders of record owned more than 30 percent of the outstandingshares in 78.5 percent of the cases and in 53.9 percent of the cases theyowed 50 percent or more. These data should be borne in min.d whenth~ impact of extension of section 16 (b) to the over-the-counter mar-ket is considered.

b. The potential impact of section 16 (b ) on market making generallyPolicy considerations and problems involved in b~ard representa-

tion of broker-dealers generally have already been canvassed in partF of chapter III and it has been seen that complex questions of obli-gation may arise where the director or his firm is also effecting trans-actions as principal or for customers. Quite apart from section 16(b),the combined functions are avoided by some firms or, when under-taken, are often subject to inhibitions or difficulties in performing onefunction or the other. Against this background, the section 16(b)question is largely reduced to determining whether the demands ofover-the-counter market making or sponsorship, while simultaneouslyserving as director, are still so compelling in over-the-counter marketsgenerally as to necessitate a general exemption for market makerswhen the section is extended to over-the-counter securities.

It should be noted preliminarily that applying section 16 and itsco~npanion sections, 13 and 14, to over-the-counter issuers would inand of itself eliminate one of the principal reasons usually advancedto justify the seeking or acceptance of ~lirectorships by broker-deal-ers-to insure a proper flow of information and a proper recognitionof other obligations of a publicly held corporation to its shareholders.Adequate financial reporting to a public agency--when proxies aresolicited--to shareholders, proxy solicitation controls desi~Tned to en-able shareholders intelligently to exercise their corporate franchise,and protections against insider-trading abuses, would make unneces-sary efforts by broker-dealer-directors to see to it that investors--moreaccurately those investors that happened to be their customers--wereadequately informed. The information essential to intelligent invest-ment. decisions would be available to investors, actual and potential,and the opportunity to take advantage of inside information wouldbe greatly reduced. The disclosure need of investors is not for broker-dealer board representation; it is for extension of the protections ofsections 13, 14, and 16 to unlisted securities. As a senior partner ofone of the largest brokerage concerns in the countL~ put it :

With respect to directorships in companies whose securities ,are n,c¢ listed, ~tis my opinion, ,that if disclosure * * * [is] required in :the fu.tt~re, the need forinvestment bankers or brokers sitting oa the boards of such companies will beminimized.

48 REPORT OF SPECIAL STUDY OF SECURITIES MARKETS

Even apart from this, however, the available data leave little ques-tion that the demands of the market-making or sponsorship functionare not compelling in most circumstances. In the first place, even onthe most drastic .assumption that all broker-dealers that both maintaintrading markets and sit on the corresponding corporate .boards were toelect to retain their board seats at the cost of abandoning their markets,only a very small segment of the whole over-the-counter market wouldbe affected. It has ’already been noted that of a total of 5,785 broker-dealers then registered with the ’Commission, only 508 of the 4,964 thatresponded to questionnaire OTC-3 indicated that they made .a marketfor one or more stocks and at the same time held directorships. Theissuers involved numbered only 1,481 or only 13.38 percent of the totalof some 11,069 different issuers which are estimated to have thenevoked at least some market interest in the 10-month periodex.amined.9.

Since the standard of coverage discussed in part ’B.3, however, re-stri.cts applicability of section 16 (b) to those issuers that have 300 more shareholders, some of even the 13.38 percent wo~ld not be af-fected. Of the 352 issues in the ’OTC-4 sample that had director-mar-ket makers or sponsors, only 85 percent had 300 or more shareholders.Those t’hat would ’be included, moreov.er, would not be deprived ofa market .althogether, since 214, or 60 percent, of the 352 .issues werebeing quoted by at least 4 broker-dealers. The withdrawal of onebroker-dealer in such circumstances would presumably have littleeffect. Overall, therefore, the actual impact of section 16 (b.) wouldat most be minimal.

Actually there is good reason to assume that many broker-dealerswould choose to resign .as directors ..rather than abandon their tradingmarkets. The latter are, ’after all, ~)rofitmaking operations; compen-sation for the former is, to repeat part of the testimony already quoted,"usuMly .minimal and completely out of proportion to the time con-sumed." Compensation aside, moreover, there is a substantiM bodyof opinion that board representation ~loes not faci’litate market mak-ing. As one wholesale broker-dealer put it:

Q. Bu’t you ~are paying ,a m, an ,a sal, ary ~or being on ,the board. Now I jus.t~,an,t you to tell me .frankly * * * whether you can possi.bly conduct ~h, at tradingoperation without makin.g use .of the inform, ati~on that he has received * * *

A. This is amazing, ,but when we tra(led ,our vwn issue we lost m.(~ney a.ndbig money. The insiders will not believe y~)u on ’this.

What happens : either there ,are .all buyers or ,all sellers. And, .either ~¢ay, wehave to make a m,arket, and we have to sell sometimes when we don’t want tosell. We will look ,a.t ’Bob’s p(~sition, .and he hasn’.t ,any pos~.tion. We h~ave ,tomake ~a .m,arket.

A partner of an "integrated" house, i.e, one that both maintainsinterdealer markets and services retail customers, said much the samething:

¯ * * .the ’informa,ti,on we have ,as directors does not i~fluence .our market ac-tivity. As we have discussed in ~)ther pl, aces, one (>f the real ,tricks in .makinga ma.rket ~is not to have ,an (~pinion .as to the value of ,the stock. We try ~o tellour trading departmen, t ’that wherea.s ,we brough, t out a ,stock ,at ,a given price,they have no obligaVion to maintain ,that price. They must let the market moveup or down with supply and demand. ’That is really the secret of making ~amarket * * *

: ~ See table IX-f, above.

REPORT OF SPECIAL STUDY OF SECURITIES MZkRKETS 49

The facts of the marketplace, indeed, show that, whatever opinionsindividual broker-dealers might, hold, board representation is certainlynot necessary to making a market. As already pointed out, the vastmajority of all over-the-counter stocks have trading markets withoutboard representation. Many of them are public utility stocks the is-suers of which are forbidden by law to include broker-dealers u.mongtheir directors. One hundred and twenty-three of the OTC-4 sampleof 1,618 were actually described as "sponsored’--enjoyed the as-sertedly most responsible species of trading market--without boardrepresentation.

In short, sections 13, 14, and 16 would themselves make academic oneof the commonly ascribed reasons for board rep.resentation; section16(b) would impinge at all on only a very small segment of over-Vbe.-counter market making; moreover, only a much smaller segment ofthe impact area could be expected to be actually significantly affected;and even that effect would be unnecessary in most if not all instancesin the sense that the alternative of resigning the directorship would beavailable.

c. The potential impact of section 16(b) in eases of market"sponsorship"

No~withstanding the considerations just discussed, it is recognizeelthat, when put to a choice, some board-represented broker-dealersmight elec~ to retain their directorships and wi.bhdraw from makingmarkets for the corresponding stocks. Even though the nun~b~rsuch withdrawals could ,be expected to be quite small, their signifi-cance might ~be thought to be large because some o~ ~he broker-dealersinvolved might be not merely market makers bu~ tha.t more important~roup calling ~hemselves "sponsors." The loss of a sponsor~ it hasbeen asserted, would deprive an issue of its most reliable market, t’heone that can be expected .~o continue during .i~riods of marke~ inactiv-ity or instability when investors’ needs are most urgent. Market con-tinuity, a willingness to purchase or sell in substantial amounts, and awillingness .to take greater positions, all have been suggested as thespecial virtues of sponsorship.

In the analysis of questionnaire OTC-4 (see pt. B.3.b, a~bove) separ~.te gtudy was made of all issues in the sample of 1,618 stockswhich price data were available, in terms of price level (high bids) two selected points of time~ near ~he peak of the general market inDecember 1961 and after the May 1962 market break. This sampleincluded 308 instances in which there was a market maker and/or asponsor represented on the board. 116 instances in which sponsorshipwas asserted (in responses to OTC-3) without board represen~a?ion,and 878 instances with nei’ther board representation nor claim ofsponsorship. In view of the size of the sample and its random selec-t.ion, it is ,believed that actual l~rice changes be’tween these points oftime for the differen~ categories are of some significance in measuringthe importance of sponsorship, wh~ther or no¢ reflected in board rep-resentation~ in relation ~o ma.rk6t performance2~

~ No doubt some of the nonsponsored stocks which reflected little price decline or ex-perienced price rises during the period were among the more inactively traded stocks.On the other hand, shareholder size and trading activity of many of those nonsnonsoredstocks wer~ equal to if not greater than for many of the sponsored stocks. The 2 ex-tremes presu.mably cancel themselves out to the p(~int whe~*e the 2 categories may appro-priateIy be compared.

50 REPORT OF SPECIAL STUDY OF SECURITIES :MARKETS

Comparing first the 116 instances of asserted sponsorship (withoutboard r~presentution) with ~he 878 ins~nces of nonsponsorship (alsowithout board representa;tion), it was found that in the former cab-gory 67 percent of the issues declined 20 percent or more in quotedprice, whereas in the la~r c~tegory this was true of only 30 percentof the issues; and on the other hand, 9.5 percent, of the former groupincreased in price, where~s 49 percent of the la;tter showed an increase.When comparison was made ’between the 30’8 instances of board rep-resen.tation (with or without asserted sponsorship) and ,the same 878instances of nonrepresentation a~d nonsponsorship, the contrasts weresimilarly striking: For the former group of board-represented issues,64 percent showed price declines of 20 percent or more ~nd only 15percent showed increases, in contrast with the above figures of 30 and 49percont for the 878 issues having neither board representation norasserted sponsorship. See table IX-g, below.

T)m~s IX-g.--Sample of issuers o~ over-the-vounter stock classified by "sponsor-ship" and percentage change in price of stock, December 1961 to June 1962

Percentage price change

Total ...............................

Decline:80 to 99 ...............................60 to 79 ...............................40 to 59 ...............................20 to 39 ...............................1 to 19 ................................

Increase:1 to49~ ...............................50 and over ...........................

Nonsponsored ~

Numbero[ issues

878

124579124189

Percentof to~al

100.0

1.4~.19.0

14.121.5

45. 53.4

Sponsored ~

Number Percentof issues of total

116 100. 0

2

3.41 10.327 23. 335 30.227 23. 3

8. 6.9

Director-marketmaker and/or

director-sponsored

Numberof issues

308

847g61

Percentof total

1.611.727.324.419. 8

13.31.9

~ Prices were obtained from the National Quotation Bureau, Inc., the National Monthly Stock Summary(issues of 5an. I and July 1, 1962). The December price represents the high bid closest to Dec. 31, 1961, andthe June price represents the high bid closest to June 30, 1962.

~ Without board representation by any market maker or sponsor.~ Includes those stocks in which there was no price change.

No~.--Sample includes approximately 1 out of 5 issuers listed in the National Quotation Bureau, Inc.the National Monthly Stock Summary ($an. 1, 1962).

Whatever the theoretical obligations involved in sponsorship, theabove analysis indicates, at the very least, that sponsored stocks, withor without board representation, do not generally perform betterthan nonsponsored ones in terms of one objective and measurablecriterion--price performance over a period including a market crisis.Undoubtedly some sponsored stocks performed better than did somenonsponsored stocks, but it would be as inappropriate to concludethat in such instances sponsorship was the cause of the superior per-formance as it ~vould be to conclude that sponsorship was the cause ofthe inferior price performance for the majority of sponsored stocksshown in table IX-g.

In the analysis of questionnaire OTC-3 ~ a further effort was madeto study the actual performance of sponsors as compared with othermarket makers, all responding broker-dealers having been asked to

See ch. VII.

REPORT OF SPECIAL STUDY OF SECURITIES MARKETS 5]

indicate those stocks of ~vhich they considered themselves a sponsor.A list of 200 stocks was randomly selected and all respondents wereasked to supply detailed schedules of their transactions in those stocksfor the 1 day (or in the case of less active stocks a longer period)selected for study. The trading of all broker-dealers who listed anyof those i~00 stocks as sponsored was studied in detail, to determinewhether sponsorship had distinguishable results in terms of the num-ber of shares traded with other dealers or with public customers andtheir prices of execution. In addition, a period of price stress wasstudied with respect to the same stocks and sponsoring firms, by meansof a followup questionnaire, OTC-5, and numerous interviews afterthe May 1962 market break.

The results of the findings are discussed in chapter VII and the ap-pendixes thereto. Generally, they show that the activity of mostsponsors for the "normal" day of January 18, 1962, and for the daysof the market break, was not readily distinguishable from the activityof other market makers in terms of their relative importance as pro-fessional participants or the price at which they executed transactions.Although some sponsors were of considerable importance in certainsecurities with limited professional participation~ these were excep-tions to the typical performance of sponsors.97

Because sponsorship seems to involve in actual practice no more thanordinary market making without a directorship, it is entirely probablethat the gap left by the ~vithdrawal from the market of a sponsor--presumably one having board representation if section 16 (b) were thecause--would in most instances be filled by some other market maker.Indeed, it has already been shown that the broker-dealer interest insponsored stocks generally is sufficiently great so that the loss of asingle dealer choosing to remain on an issuer’s board would not depri’~emost such stocks of active broker-dealer interest28 And as alreadyindicated, for those relatively rarer situations where sponsorshipmight be indispensable~ ~vithdrawal from board representation is analternative frequently chosen and sometimes compelled (in the in-stance of public utilities) even without any compulsion of section16(b). As will be seen in the following discussion of small businessinvestment companies, still another possibility that some broker-dealers have found workable is to conduct a trading market with suchlimited accountability for profits as section 16 (b) might entail.d. A~lysis of the impact of section 30(f) of the [~vest~vent Company

ActIt has been possible to observe the actual over-the-counter impact of

section 16(b) in one limited area, that occupied by small businessinvestment companies (SBIC~s), a species of closed-end investmentcompany authorized by the Small Business Investment Act of 19582~Section 30(f) of the Investment Company Act, to which SBIC’s aresubject, has ~lways by reference applied section 16(b) to closed-endcompanies~ both listed and unlisted, but until SBIC’s came on thescene such companies were generally exchange traded and no specialproblem of impact on over-the-counter trading markets was presented.

~ Ibid.~s See ~ubsec. a, above.~ 15 U.S.C. 681 ft.

52 REPORT OF SPECIAL STUDY OF SECURITIES 1V~ARKETS

Since 1959 however, publicly owned SBIC’s---the vast majority ofwhich are unlisted--have offered valuable, if limited, material for a"pilot study" of the actual reactions of broker-dealers and issuers toover-the-counter applicability of section 16 (b) and the actual conse-quent market behavior of the issues involved.

By the end of 1961, 40 SBIC’s had registered issues under the Se-curities Act and were publicly traded, 39 over the counter and 1,Venture Capital Corp.., on the American Stock Exchange. In 1962,a second SBIC,1°° Business Capital Corp., was listed on the MidwestStock Exchange. Three SBIC’s, Boston Capital Corp., Midland~Capital Corp., and St. Louis Capital Corp., were among the 200 OTC-3stocks chosen for trading analysis. (See chapter VII.) Insofar the market aspects thus studied are concerned, the three stocks appearto reflect no significant variation from other securities in the OTC-3sample of compars~ble size and activity.

The SBIC pilot study was carried out as follows: All annual re-ports and proxy solicitation materials filed with the Commission byeach of the 39 SBIC’s were scrutinized for such information as num-ber of stockholders, asset size, a~d the names of any directors whoappeared to be broker-dealers. All ownership reports of these direc-tors were then reviewed, as were their firms~ responses to questionna.ireOTC-3 regard.ing the over-the-counter markets which they made. Rep-resentatives of several of the broker-dealer firms that were at any timerepresented on the board of an SBIC were then interviewed as to thenature and extent of their firms’ trading in the stock of the corpora-tion, both in periods when they were represented and when they werenot. Finally, the market performance of those stocks were studied.

(1) The reactions of broker-dealer directors to section 30(f)In the case of 7 of the 39 SBIC’s, at no time since their initial public

offering has a broker-dealer been represented on the board. Five ofthe seven had trading markets regularly maintained by one or morebroker-dealers, three of which were "sponsored." The 7 as a groupare entirely representative in other respects of the whole group of 39;their stockholder families range in number from 750 to more than11,000 and asset sizes range from just over $1 million to more than $14million. The corporate attributes of the issuer therefore supply noexplanation for broker-dealer absence from the boards. In one case,section 30 (f) was stated to have been the sole factor, and in another,where the underwriter did not make a market, section 30(f) was nota problem. But clearly the group of 7 as a whole shows the Invest-ment Company Act equivalent of section 16 (b) to be far from fatalto the making of over-the-counter markets.

All of the remaining 32 SBIC’s have at some time had a broker-dealer board member and invariably his firm was either an under-writer or a principal member of the selling group that offered thestock to the public. In 6 of the 32 cases, the broker-dealer boardmembers resigned as directors at varying times subsequent to thepublic offering, so that their firms could continue to trade the com-pany’s stock without section 30(f) liability. Each submitted hisresignation immediately upon becoming aware of potential liabilityand deciding that it was more important to continue to maintain a

a~ One of the 39.

REPORT OF SPECIAL STUDY OF SECURITIES I~RKETS 53

trading market than to continue the directorship.. None of the firmsinvolved indicated that the nature and extent of their market-makingactivities was altered after they gave up board representation. One,however, said that without it, "we deal a little more in the dark to-day." Here again, the equivalent of section 16(b) clearly had mini-mal effect on trading markets for the issues involved.

Another 17 of the 39 SBIC’s had .among their directors a repre-sentative of an investment banking firm which underwrote the com-pany’s stock or was a principal member of the selling group, butwhich did not maintain a trading market for its stock. In certain of

--these 17 cases, a choice may not have been required. Thus, in one,the broker-dealer firm made no trading market in any stock; in asecond, the number of stockholders was so small and the market solocal that a trading market wasneither required nor feasible; and ina few others, an easy solution was at hand, since two broker-dealerfirms were represented on the issuer’s board and the directorships andmarket making could easily be divorced. In several of the 17 cases,however, the investment banking firms involved were required tochoose, and because they felt that board representation was of fore-most importance, potential liability under section 30(f) dictated decision to refrain from trading the stock. It should be noted thatapparently all but 1 of the 17 companies continued to have a tradingmarket for their stocks, since throughout 1962 two-way quotationsappeared in the wholesale quotation sheets at least weekly for all ofthe companies except the one referred to above that had very fewshareholders and primarily a local market.

In only two cases of the underwriter’s withdrawal from the marketfor the stock of an SBIC have the companies themselves reactedoverfly. One, Growth Capital, Inc., applied to the Commission for anexemption or special treatment for one of its underwriters, McDonald& Co., so that the firm could resume trading the stock without subject-ing its principal officer, who is a member of Growth Capital’s board,to full liability under section 30(f).~ The second, Business CapitalCorp., secured a listing for its stock on the Midwest Stock Exchangein June 1962, as noted above, primarily because its underwriter feltthat the company’s stock would thereby enjoy the more stable andcontinuous market which it could not provide because of its boardrepresentation.

Finally, nine of the SBIC’s contihued to have the board representa-tion of broker-dealers while their firms traded the company’s stock.Essentially they fall into. three groups: three in which the broker-dealer was represented by an employee, as contrasted with a principal,and therefore under present law apparently considered not subject toliability; another three in which the beneficial interest of the broker-dealer in his firm was so small, or the firm’s trading profits consideredto be so liraited, that the potential liability was apparently consideredminimal; 102 and still another three in which the affiliated director wassimply unaware of the provisions of section 30 (f).

lo~ fl:he case is still pend4ng.lo~ As a matter of course, one such broker-dealer director regularly files with his owner-

ship reports a copy of his letter to the corporation transmitting payment of his rathernominal liability for profit from the preceding month’s transactions.

54 REPORT OF SPECIAL STUDY OF SECURITIES IVIARKETS

(2) The market performance of SBIC stocks, both with andwithout trading markets made by their underwriters

The study charted the week-to-week price movements throughoutthe year 196o. of each of the 40 SB’IC’s publicly held on December 31,1961., and regularly quoted in the eastern "sheets" of the NationalQuotation Bureau or traded on a national exchange. In all cases, thehigh bid (or closing price in the case of the two stocks listed in 1962)of the last trading day of each week was taken as the charting point.In addition, the day-to-day movements of the same companies for theperiod May 21 to June 8, 1962, were plotted.

There appears to be no correlation between the presence or absenceof an underwrii~r making a market and price movement measured inthese ways. It thus seems clear from the analysis that, whatever theeffect of market making by underwriters from transaction to trans-action, their presence or absence from the markets for SBIC stockswas not a material factor affecting week-to-week or daily price move-ments, even over a period of price fluctuation such as the year 1962,and particularly the 3-week period selected for daily analysis. Al-though this is admittedly only a limited test of total market behavior,it can at least be said that. the choice made by individual broker-dealerfirms between making a market and retaining board membership doesnot appear, by itself, to have made an appreciable impact upon themarkets for SBIC stocks when measured in terms of price trends.

e. Conclusion as to section 16 (b)From all of the above, the conclusion is inescapable that the potential

effects of section 16 (b) on over-the-counter trading markets havegreatly exaggerated. The available objective data indicate that formost if not all situations, the choice between serving on the board ormaking a market is not an impossible one and that neither thefected corporations nor the market for their securities need be harmedif the choice is compelled by section 16 (b). The broad conclusion the study, which is in accord with the publicly expressed view of oneof the most knowledgeable authorities covemng over-the-countermarkets, Wallace H. Fulton, the retiring executive director of theN/kSD,1°3 is that section 16(b) should apply generally to unlistedsecurities.

The present section 16(b) excludes from its coverage "* * * anytransaction or transactions which the Commission by rules and regu-lations may exempt as not comprehended within [its] purpose." Todate the Commission has promulgated eight rules exempting varioustypes of transactions, and industry representatives have urged thatany extension of section 16(b) to over-the-counter stocks should pro-vide exemption for market makers. As one investment banker putit:

I would not object to the addition of a new subsection to section 16, whichwould provide fo.r the section’s application to the over-the-counter market. How-ever, there should be an exception; that exception should be the exemption ofthe for~."eiture of insider profits when profits, are made by a firm trading account,the exact language of the exemption to be defined by rules and regulations.

In view of the foregving discussio~ i’t is clear that a general exemp-t~ve provision of such nature is unwarranted. If ther~ are truly

ao~ New York *rimes, Feb. 27, 1962, p. 51.

REPORT OF SPECIAL STUDY OF SECURITIES 1VIARKETS 55

exceptional circumstances or instances--possibly, for a limited periodof years after a first public offering and/or in the case of geo-graphically restricted markets--in which it can be afi3rmatively shownb.ot:h that the same broker-dealer is uniquely available and essentialfor simultaneous board membership and ,narket making and that it isnecess’ary and appropriate in the public interest and f~r the protectionof investors that ’his trading profits be exempt, such exemption maybe provided for by rules of hmited scope or on application of theissuer.

6. AN ~OTC-LISTED" CATEGORY

Since it is contemplated that some issuers of securities in over-the-counter markets will and others will not be required to comply withsections 13, 14, ~n.d 16, the di.stinction will and should become u highlyimportant one for many purposes. Thus, in ,chapter III, relating toselling and investment advisory practices, it is recommended that the.availability or nonavailabil’ity of officially filed d~ta concerning an~ssuer be required to be reflected in appropriate ways in the selli’ngprocess. Similarly, in chapter IV it is recommended that, with ’re-spect to issues for wh’ich a reservoir of officially filed informat.ionexists--listed issues and those unlisted issues to whic:h sections 13, 14,an’d 16 would apply--consideration shou’ld be given to pos’sibilitiesfor expediting and si’mplifying the Securities Act registration processin recognitio~ of that fact. Again, one prerequisi’te for regulwrizingand improving quotation systems and procedures as recommended in.chapter VII is identification of a group of issues, in connection withthe rou.tine newspaper or electronic quotation systems, that would besurrounded by at least the minimum investor protections of the threesections. Any changes in present provisions as to eligib~ility of over-the-counter securities for exten’si:on of credi.t, as discussed in chapterX, would be dependent on regular and reliable quotations as well asreliable underlying ’informat.ion for those issues which might be con-sidered eligible. Finally, i~ may be anticipa.ted that in many lessformal ways, in the day-to-day opera.tions of broker-dealers and theroutine concerns of t’he investing public, ready identification ofaffected issues will be important and desirable. As a distinguishinghallmark, therefore, the term "OTC-listed" is suggested ~ a statutorydesignation for over-t~he-counter securities to which the continuingobligations of sections 13, 14, and 16 will apply.

Actually, the distinctions mentioned in the preceding paragraphexemplify what may be a considerably broader opportunity to adjustregulatory measures to needs. As pointed out in chapter VII, an im-portant characteristic of over-the-counter markets and securities istheir heterogeneity. This being so. a degree of categorization becomesuseful if not essential for many regulatory as well as business purposes.Given a wide range of kinds and sizes, needs and possibilities, anyuniform and undifferentiated measures are certain to be unsuitable formuch if not most of the field to be covered. Rights and benefits mayhave to bs denied to some because it is impossible to grant them at all.Restrictions and regulations may have to be kept to the lowest commondenominator---to the detriment of investors--because what would beappropriate for some crucial segment would be impossible for the vastbody ; alternatively, regulation essential for the crucial segment would


be imposed on areas where they would be unnecessarily burdensome.The OTC-listed concept may thus be regarded as establishing a basiccategorization--founded on the all-important distinction of whethercontinuing protections of sections 13, 1¢, and 16 are or are not avail-able--that can undoubtedly be used in various ways to adjust privi-leges and obligations in the marketplace to the needs of each category.

The term and the category need not be restricted, indeed, to onlythose issues meeting the applicable number-of-shareholders criterion,since it may be anticipated that some, and perhaps many, issuers outsidethe mandatory group will find it desirable to bring themselves into theselect category by voluntary compliance, and achieve both the statusand privileges related to it. There would appear to be no reason oftheory or practicality why this should not be encouraged. Legislationto extend sections 13, 14, and 16 and confer the OTC-listed desig-nation should therefore provide that any issuers not required to complymight elect to do so and become entitled to be designated "OTC-listed."

7. SECTIONS ~5(d), 12(f)(3), AND RULE 12f--4,

Extending sections 13, 14, and 16 of the Exchange Act to unlistedsecurities, under the phase coverage standard proposed abovesuggests the desirability of adjusting two other provisions of the Actand a Commission rule in order to provide a harmonious whole. Thefirst statutory provision, section 15 (d) of the Exchange Act, requiresissuers that register an issue for public offering under the SecuritiesAct to undertake to comply with section 13, the reporting requirement~when outstanding securities of the class registered aggregate $2 million,computed on the basis of the offering price. Reporting must continueuntil the amount outstanding, computed on the same basis, falls below$1 million (as a result of redemptions, treasury purchases, etc.). Thesecond section, 12(f)(3)~ makes certain issues eligible for unlistedtrading privileges on an exchange. The Commission’s rule, 12f-4,exempts issuers of such securities and all other categories of securitiesadmitted to unlisted trading privileges from sections 13, 14=~ and 16,with which they would have to comply except for the rule.

Section 15(d), added to the Exchange Act in 1936, was based the rationale that whatever might be the obligations of issuers of pub-licly owned securities generally, the very fact that an issuer resortsto the public to raise new funds in substantial amount is sufficientbasis for requiring at least adequate reporting to that public. Section15(d) has been a valuable protective force in the over-the-countermarket, but its rationale results in less embracing coverage than thathere recommended. Going to the public for capital obviously shouldentail concomitant ~bligatio.ns to that public, but the same obligationsshould be owed, and under the above proposals will be owed, to share-holders of any publicly held company, quite independently of any linkto the registration process as such. Similarly, when protection is ex-tended to all shareholders of publicly held companies to whom it canfeasibly be extended, a standard of coverage based in part on the totalmarket value of the issue becomes inappropriate. Section 15(d),moreover, provides no proxy and insider-trading controls at all. Ifit were practicable, therefore, immediately to extend the benefits ofsections 13, 14, and 16 to all issuers that have 300 or more shareholders,

REPORT OF SPECIAL STUDY OF SECURITIES lYL(RKETS 57

the ultimated coverage recommended, section 15 (d) would no longerbe needed.

Until that ultimate coverage is accomplished, however, section 15 (d)might usefully play a part in the "phasing-in" program recommendedabove. That program is geared exclusively to practical considera-tions, and it appears quite consistent with these practical considera-tions to include additional companies as and when they register for apublic offering and meet the ultimate test of 300 or more shareholders,even if not meeting the higher criteria temporarily in effect ~or othercompanies. Section 15(d) of the Exchange Act should therefore modified to require M1 issuers that register an issue pursuant ~o theSecurities Act to undertake to comply with sections 13~ 14, and 16 ofthe :Exchange Act if and when the nun~ber of their respective share-holders of record reaches 300. By parallel reasoning the same resultshould apply to issues offered under regulation A. To the extentpossible, Commission rules should be modified to require compliancewith the three sections accordingly.

In the case of issues enjoying unlisted trading p.rivileges on ex-changes~ both a statutory and a rule amendment are in order. Threecategori~ of issues are eligible for such privileges: (’1) issues tradedunlisted before the Exchange Act came into force and permitted to con-tinue to be so traded--section 12(~) (1) ; (2) issues fully listed on other exchange--section 12(f) (2) ; and (3) issues as to which su’bstantially equivalent to those for. listed securities are available--section 12(f) (3). Issues in the second category, present no problemhere because comoliance with sections 13, 14, and 16 is required in anycase by reason of full listing on some exchange. The statutor:~, andrule amendments called for relate to the first and third categories.

Extension of sections 13~ 14, and 16 to unlisted securities suggestseliminating the third .category altogether~ by statutory amendment.Vv~hen suc]~ extension has been accomplished, all included issues nowtraded over the counter would prima facie be within the orbit of sec-tion 12(f) (3), and a multitude of applications by exchanges for listed trading privileges might ensue. Although the Commission isthe ultimate arbiter under section 12(f)(3)~ it would seem better

~eermit the choice between exchange and over-the-counter trading todetermined by the preference of issuers and ordinary competition

among markets~’but freed of the regulatory disparity .between the twomarkets brought about by the Exchange Act. As sections 13, 14~ and16 are extended to unlisted issues, therefore, section 12 (f) (3) eligibil-ity should be concurrently withdrawn.

Elimination of the regulatory disparity, finally, would destroy thejustification for the general exemption from sections 13~ 14, and 16 nowafforded to section 12(f)(1) issues by rule 12f-4. That rule promulgated because in the absence of an exemption, issuers admittedto unlisted trading might have been tempted to avoid compliance withsections 13, 14~ and 16 at the risk only of loss of the exchange~s unlistedtrading privilege. Rule 12f-4 should therefore be amended to exemptsection 12 (f) (1) issuers only in the qui’te unlikely case that they less than the number of shareholders applied as the test of coveragefor over-the-counter sec.urities.

96746 O--63--pt. 3~5


8. I]~IPROVEI~ENT OF EXISTING INVESTOR PROTECTIONS

In addition to .extending sections 13, 14, and 16 to unlisted securi-ties, experience has shown a need to improve the protections providedby those sections for listed (and hereafter also unlisted) securities certain respects:

When proxies are solicited, it is important to insure that financialstatements included in company reports to shareholders accompanyingor preceding proxy solicitations--required by the rules when manage-ment solicits proxies for an annual meeting--~be presented on the samebasis as that of those filed officially. Rule 14(a)-3(b) under the change Act now requires that such reports adequately reflect~ in theopinion of the management, the financial position of the corporation,but management opinion has on occasion proven to be woefully inade-quate, indeed so far from the-requirements of form 10-K as to be seri-ously misleading; see, for example, the discussion of suspension oftrading of the stock of Atlantic Research Corp. in chapter III and partC of this chapter, below. Rule 14(a)-3(b) should therefore amended to require that the reports ~vhich must accompany or precedeproxy solicitation be not misleading in the light of the requirements ofform 10-K and the accounting rules governing preparation of reportson that form.

Another proxy-solicitation precaution should also be mentioned:Section 14(b) of the Exchange Act empowers the Commission adopt rules governing the manner in which broker-dealers giveproxies on listed securities carried for the account of c~astomers.Presumably because the Commission has no authority to compel theactual giving as contrasted with the manner of giving such proxies,and because the principal exchanges have a~lopted pertinent rules,the section 14(b) powers have never been exercised. The exchangerules need not be evaluated to conclude that corresponding rulesshould be adopted by the NASD. They are needed now~ but will beindispensible when section 14 applies to unlisted securities. The rec-ommended legislation should also confer on the Commission adequatereserve powers in respect of both listed and unlisted securities.

Finally, it is also appropriate to refer to the question posed in theca,se of Bla~u v. Lehman, 368 U.S. 403 (1962), in which the Commissionurged a reading of section 16’(b) to cover the full insider-tradingprofits of a partnership, a member of which serves as a corporate di-rector subject to the section, rather than merely the single director-partner’s proportionate share. In this case the Supreme Court feltcompelled to reach the more limited result because the partner-direc-tor had not been "deputed" as such by the partnership and had notknown of the transactions in the corporation’s stock until after thefirst of them was made, and the statute, as the Court interpreted it,did not in the circumstances makes the partnership a director. Thisconclusion left a large loophole in the insider-trading ban, since houseslike Lehman Bros. are frequently represented on many boards andthe limitation of section 16 (b) to merely one partner’s share of profitsmay conceivably permit all to benefit from each one’s inside informa-tion .at the cost o.f relatively insignificant forfeitures. To leave theprotection of the section dependent on piercing the murky questionswhether a partner has been "deputed" to act as director on behalf


of his firm and whether or to what extent he has had a hand in itsinsider transactions is inconsistent with the rationale on which thesection is based.

The Supreme Court decision was based, of course, on statutory inter-pretation rather than consideration of policy. The arguments ofpolicy should therefore be presented to Congress, as the SupremeCourt suggested, and Blau v. Lehman should be reversed by appro-priate statutory amendment.

As pointed out in another connection in chapter IV, required dis-closures under the Securities Act are.of two kinds, those intended foractual transmittal to investors--essentially prospectuses and proxy.~tatements--and those merely required to be filed publicly--includingreports of issuers under section 13 and of insiders under section 16 (a)of the Exchange Act. The virtues of mere public filing of specifiedinformation, under the statutory sanctions, should not be discounted:Undoubtedly it has great prophylactic effect on those required to dis-close; at least the true professionals in the financial community can beexpected to use and understand it; and in various ways and varyingdegrees it does reach members of the general investing public. Never-theless, to the extent that disclosure is unused and unheeded, its ulti-mate purpose is frustrated. The Commission and the self-regulatoryagencies could go further in fostering, in various ways, wider dis-semination of publicly disclosed information and its more consistentuse in selling and advisory processes.

Taking the later first, it is recommended in chapter III that thereservoir of filed information about, an issuer--and after extension ofsections 13, 14, and 16 as recommended above, this would includeissuers of OTC-listed as well as exchange-listed securities--should berequired to be used to a greater extent in research, advisory and sellingactivities, and that the obligations of broker-dealers and investmentadvisers in this regard should be appro!~riately defined from time totime by the Commission and other regu,atory authorities. It is sug-gested, for example, that broker-dealers and investment advisers whosell or recommend specific securities ought to be under an ~ppropri-ately described obligation to consult officially filed information whereavailable and to make copies available to their customers. These fewthoughts, however, do not necessarily exhaust the possibilities thatmay exist for bringing the statutory disclosure processes into moreactive and meaningful use in connection with advisory and sellingactivities.

A still broader point is that wider dissemination or at least wideravailability of filed information ought to be generally fostered.Today’s advanced techniques for spe.e~y and inexpensive communica-tion and duplication of the printed ~ ord make quite obsolete and in-adequate the present system---essentially unchanged for a generation--of r.equiring "public" filing in but one or two locations and providingcop~es only with considerable delay and at substantial cost. It wottldseem perfectly feasible to establish a system w’hereby filed reports ofissuers would immediately be duplicated and distributed, for example,to all regional offices of the Commission and district offices of the


NASD and, upon request and at a nominal 6barge, to any broker-dealeror member of the public. It should even be possible to standardize thephysical presentation of reports sufficiently so that up-to-date in-’formation about an issuer could be made available in some kind oflooseleaf form in the manner of present privately published services.The possibilities would seem to be numerous and varied and at leastsome of them should prove, now or in the foreseeable future, wellwithin the bounds of practicality. With minimum burdens, the bene-fits of bare filing might be multiplied greatly through imaginativemeasures of this kind.

In other, respects, too, the general goal of fostering public awarenessand use of disclosed data in making investment decisions should be acont!nuing and active concern of the regulatory authorities, so thatmaximum benefit may be derived from the disclosure which it is theba.sic purpose of the Federal securities laws to provide. For example,continuous educational measures of various kinds, to advise the publicof what prospectuses are designed for and what they contain, whatkinds of reports of issuers are publicly available, and why their con-tents or particular portions need be read and heeded, would seem to bean appropriate or even necessary function of the Commission.

10. SU/~II~IARY, CONCLUSIONS, AND RECO~]~IENDATIONS

Disclosure is the cornerstone of Federal securities regulation; it isthe great safeguard that governs the conduct of corporate manage-ments in many of their activities; it is the best bulwark against reck-less corporate publicity and irresponsible recommendation and saleof securities. In light of such considerations, it seems wholly inde-fensible, in terms of logic and of public policy, that most investors inover-the-counter securities should be afforded drastically less pro-tection than is provided for investors in exchange listed securitiesthrough sections 13, 14, and 16 of the Exchange Act. It is a.lso highlyanomalous that market allocations (in the sense of selections betweenexchange markets and over-the-counter markets) should be impor-tantly affected by a sort of Gresham’s law whereby many issuers mayavoid the protective measures applicable to all listed securities bysimply electing to have their securities traded over the counter. Issuestraded in over-the-counter markets are far too numerous and im-portant-partly as a result of this Gresham’s law--to permit thepresent anomalous distinction to continue.

Investors in all exchange listed securities are afforded protectionboth by statute and by rules of various of the exchanges. The Ex-.change Act requires full information about an issuer to be disclosedm a publicly filed application for registration before securities of theissuer may be listed for trading on an exchange, and requires the in-formation to be kept current by subsequent periodic and current(special) reports (sec. 13). It also requires that complete informa-tion be supplied shareholders in accordance with Commission ruleswhen proxies are solicited (sec. 14). Finally, the Exchange Actcontrols the use of confidential corporate information for personalgain by requiring public disclosure of insiders’ transactions in theequity securities of their corporations and providing for the corporate

. recovery of resulting "short-swing" profits.


Statutory protections are supplemented by the exchanges. Theprincipal New York exchanges, for example, in their listing agree-ments require all listed companies to disseminate independently audit-ed financial statements to share holders annually, and require mostcompanies newly listing securities to publish quarterly statements ofearning.s as well. The New York Stock Exchange also requires listedcompames to solicit proxies for all meetings of shareholders. TheAmerican Stock Exchange is in the process of extending the samerequirement to all of its issuers of listed issues. Certain of the regionalexchanges provide the same or similar protection.

By contrast, comparable protections in the over-the-counter marketare provided for only limited classes of securities and, for some ofthose, only in part. A vast number of issuers of over-the-countersecurities are not required to file reports or to furnish their share-holders with adequate information when proxies are solicited, norare they subject to insider-trading controls. A limited number ofissuers are subject to reporting requirements only, by reason of aprior public offering, and a limited number are required to supplyshareholders with annual financial statements in order to have se-curities eligible for the retail quotation lists of the NASD, but eventhese partial protections apply to securities comprising only a smallpart of the over-the-counter market. Viewed as a whole, that marketpresents a striking regulatory disparity with exchange markets.

The disparity and the need to eliminate it have long been recog-nized. When Federal securities laws were first enacted, Congressitself expressly provided for "comparable protection" and variousstudies since then, which the Special Study has confirmed, havedemonstrated the need. Legislation to accomplish the desired endhas been proposed in the past, but has failed of adoption at least inpart becaus~ of unresolved questions as to its scope of coverage. In-deed, the open questions in this area cannot be questions of pr~nc.ipleas to whether or not the protections are desirable, but only questmnsof where lines should be drawn in the light of practicalities.

The Special Study attempted to assemble data that would be helpfulin determining the scope of remedial legislation. It is establishedlaw that an offering may be "public" for purposes of the registrationrequirements of the Securities Act, whatever the number of personsinvolved, if the circumstances are such that the protections affordedby registration are needed. By parallel reasoning, if securities arealready traded in public markets, the protections of sections 13, 14,and 16 theoretically should not depend on the size of the issuer orthe number of its security holders. Nevertheless, practicalities of ad-ministration made it advisable to seek data bearing on the number

- of companies that would be affected by various coverage criteria andsome of the characteristics of those that might be included and ex-cluded.

A comprehensive survey of issuers of over-the-counter stocks--more comprehensive than any before attempted--leads to the conclu-sion that a number-of-shareholders criterion of coverage (the kind ofstandard principally adopted in prior legislative propo.sals) is bothmost theoretically sound and most workable. Comparisons of cor-porate characteristics and numbers of shareholders of the correspond-ing issuers show that a clear relationship exists between shareholders


¯ size and the apparent degree of trading activity indicated by numbersof transfers of record and frequency of broker-dealer quotations.Little, if any, relationship between either of the foregoing and assetsize is apparent. In the light of the detailed data set. forth, includingestimates of the total number of companies affected, a coverage stand-ard of 300 shareholders is indicated. Administrative needs, however,suggest a phased program of reaching that standard gradually by atfirst adopting a higher figure and progressively lowering it as ad-ministrative means are made available.

The potential impact of section 16 (b), the insider-trading provision,on broker-dealers who both maintain dealer markets in securities andsit on the corresponding corporate boards of directors appears to havebeen greatly exaggerated. Only a small segment of all over-the-coun-t, er issues are involved; many broker-dealers, if faced with the choiceof resigning as director or abandoning a trading market, would doubt-less choose to resign rather than cease trading; and except in a veryrare case it is difficult to conceive of any individual~’s indispensabilitya,s both director and market maker. Nevertheless, if such indispen-sability can be affirmatively shown, the Commission should be em-powered to grant exemption from section 16 (b). A general exemptionfor market-making transactions would be unwarranted.

Over-the-counter securities which are made subject to sections 13,14, and 16 will be a special and distinct segment of over-the-countersecurities for many regulatory and business purposes. To distinguisht, hem appropriately, a designation such as "OTC listed" should beofficially recognized. Issuers not subject to mandatory compliancewith sections 13, 14, and 16, should be permitted to have their securi-ties "OTC listed" by electing to comply.

Apart from extending existing protections for listed securities toover-the-counter securities, improving the existing protections in cer-tain respects and wider dissemination of officially filed informationwo~lld be desirable in any event.

The Special Study concludes and recommends:1. Sections 13, 14, and 16 of the Exchange Act should be ex-

tended, to issuers of unlisted securities, in the first instance to allissuers having 750 or more equity security holders of recordand/or known beneficial holders, and, thereafter as rapidly asfeasible to all issuers having 300 or more such holders, subject tothe exemptions and exemptive powers recommended below. Anissuer once subject to sections 13, 14, and 16 should continue tobe so despite the fact that its number of equity security holdersfalls below 300 from time to time and should be relieved of com-pliance only after that number falls to and has remained at orbelow 200 for (say) years, an d th ereafter on ly so lon g as thenumber remains below 300.

2. Section 15(d) of the Exchange Act is based on the principlethat an issuer entering the public markets for capital shouldundertake continuing obligations to investors in those markets,if the amount of the issue (plus other securities of the same class)is at least $2 million. Under the recommendation made above toextend sections 13, 14, and 16 to all over-the-counter issuers thathave 300 equity security holders a different and more embracingpractical standard will become applicable, whether or not the


issuer undertakes a new public offering. Since a phased approachto the ultimate coverage recommended is proposed on purelypractical grounds, however, and since it does not appear to be im-practical immediately to apply the ultimate standard to all issuershereafter making a public offering, section 15(d) should amended to apply the protections of sections 13, 14, and 16 toevery issuer making a public offering and thereafter having 300or more equity security holders. Issuers of future regulation Aissues should be similarly provided for by appropriate amendmentof the applicable regulations.

3. Since extension of sections 13, 14, and 16 to over-the-counterissuers will make their securities prima facie eligible for unlistedexchange trading privileges under section 12(f)(3) and it wouldbe better to leave determination of the principal market in whichan issue is traded to competition among markets and issuers’preferences, section 12(f)(3)-of the Exchange Act should be currently repealed. Rule 12f-4, which exempts from sections 13,14, and 16 issuers of issues granted unlisted trading privilegespursuant to section 12(f)(1), should be amended so that the emption will be available only where the number of shareholdersis less than the prevailing criterion for over-the-counter securities.

4. In principle, the recommended legislation should not exemptany category of issuers merely because they file reports or areotherwise regulated under other laws, unless such reports orother regulations are clearly designed for the protection of in-vestors (as distinguished from consumers, policyholders, deposit-ors or other categories) and do in fact provide protections reason-ably equivalent to those of the Exchange Act. The legislationshould expressly exempt only securities already defined as"exempted securities" by section 3(a)(12) of the Exchange (essentially Federal, State and municipal securities) and securi-ties of nonprofit organizations, but the discretionary exemptivepower granted to the Commission by section 3(a)(12) should available to enable it to exempt other categories upon a findingthat their inclusion is not required in the public interest or for theprotection of investors. The Commission should, as is now thecase with respect to listed securities, permit any issuer filing datawith any other Federal or State regulatory agency reasonablycomparable to those required under section 13, to file copies ofsuch data in lieu of data otherwise required under section 13.

5. There is no need for a general and broad exemption fromsection 16(b) requirements (relating to "insider" trading) respect of broker-dealers making markets in securities of issuerson whose boards of directors they are represented. Entirelyapart from the merits of broker-dealers’ services on corporateboards generally, the combination of making a market in an issue(as "sponsor" or otherwise) and representation on the board the issuer appears to be in most, if not all, circumstances an un-necessary one; and when consideration is given to the potentialconflicts of interest inherent in the combination, 1°4 the balanceclearly does not lie in favor of a general and broad exemption.

ao~ See oh. III.F.

64 REPORT OF SPECIAL STUDY OF SECURITIES 1VIARKETS

To provide for any truly exceptional circumstances or instances(possibly, e.g., for a limited period of time after a first publicoffering and/or in the case of geographically restricted markets)the Commission should be empowered to provide limited exemp-tions on an affirmative showing both of unique need of the issueror class of issuers and necessity and appropriateness in the pub-lic interest and for the protection of investors.

6. Since it is contemplated that some issuers of securities inover-the-counter markets will, and others will not, be required tocomply with sections 13, 14, and 16, the distinction will and shouldbecome a highly important one for many purposes; see, for ex-ample, paragraph 5 of conclusions and recommendations underchapter III.B, paragraph 1 under chapter IV.F, and conclusionsand recommendations under chapters VII and X. The term"OTC-listed" is suggested as a distinguishing hallmark for anyover-the-counter security the issuer of which is required to complywith sections 13, 14, and 16. The legislation should expressly per-mit any other issuer to elect to comply, and thereby to bring itssecurities within the "OTC-listed" category.

7. Both in their present application to exchange-listed securitiesand in their proposed application to "OTC-listed securities, sec-tions 13, 14, and 16 or the regulations thereunder should beamended to provide improved protections in certain particulars:(a) Except in extraordinary circumstances, to be defined, finan-cial statements included in reports to stockholders accompanyingor preceding proxy solicitations should be required to be preparedand presented on substantially the same basis as the financialstatements in officially filed reports; (b) appropriate rules withrespect to broker-dealer transmission of proxy-soliciting materialshould be adopted by the NASD and section 14(b) of the ExchangeAct should be amended to empower the Commission both to com-pel the giving and to control the manner of giving proxies oncustomers’ securities, both listed and unlisted; (c) section 16(b)should be amended to permit recovery of short-swing profits of abroker-dealer firm where one of the principals is a director,"reversing" Blau v. Lehman.

8. If disclosure of information is fundamental in Federalsecurities regulation, the widest possible dissemination and useof filed information will obviously best serve the purposes ofdisclosure. In light of modern techniques for duplicating andcommunicating the printed word, it would seem that disseminationand not mere filing should be required in many instances. Forexample, just as there are now unofficial services that regularlydistribute summaries of data concerning individual securities, itwould seem feasible to require officially filed information to bepresented in form for inexpensive duplication and distribution.It would also seem possible to require that copies be filed inappropriate Commission or NASD offices and/or that broker-dealers making markets or recommending purchases have copieson file or actually distribute them to customers in stated circum-stances. The technical and economic feasibility of such measuresand the advances in investor protection that they would makepossible should receive immediate and continuing study by theCommission and the self-regulatory agencies.

REPORT OF SPECIAL STUDY OF SECURITIES IVIARKETS 65

C. CORPORATE PUBLICITY AND PUBLIC RELATIONS

1. INTI~ODUCTION

Informal corporate publicity is an important supplement to thedisclosures required by the securities acts. In order to keep share-holders, the investment community, and the general pu’blic continu-ously informed of corporate developments, it is desirable for issuersto d.isseminate publicity through the channels of news distributionas well as by other means. This fact has been recognized by theCommission, which has encouraged publicly held corporations toemploy publicity and public relations for these purposes.1°5 One au-thority recently stated :

Oorpora~tions have come a long, long way in the last 35 years or so in makingin.formation available for the use of stockhol.ders and the ii~vestment fraternitygenerally. The widespread ownership of U.S. corpora’ti~)ns deepens the neces-sity for better and more timely corporate disclosure.1~

Since the 1930’s, a specialized industry has grown up to meet thedemand for professional services in handling corporate publicity. Ingeneral, the financial public relations consultant is responsible forcommunications from publicly held companies to their stockholdersand the financial community.~°7 Although there are no reliable sta-tistics on the size of the financial public relations industry, there isevidence that its growth has been rapid during the last few years.The 1962 edition of the Financial Publicists Directory, published bythe Investment Dealers Digest, lists approximately 600 firms, an in-crease of 23 percent over 1961.

The growing recognition of the need for keeping stockholders andinvestors informed of corporate matters has been marked .by a greaterflow of useful information from publicly held companies. At thesame time, abuses of the financial public relations function have be-come increasingly evident. In recent years, and particularly duringthe speculative bull market that preceded the 1962 market break, theCommission and its staff have become aware of disturbing signs thatpublic relations consultants and corporate public relations departmentshave been used for purposes contrary to the letter and the spirit ofthe securities acts. In a ~videly publicized case, the Commission foundthat publicity had been used illegally as a selling device in violation ofthe registration and prospectus requirements of section 5 of the Securi-ties Act of 1933.~°8 Several instances have come to light in which ithas appeared that misleading publicity has directly affected the marketprice of securities.

For these reasons .the Special Study decided ’to include the sub.~ectof financial public relations ac’tivities as part of i’ts study and investi-

lo~ "There has been an incre~sing tendency, particularly in the period since World WarII, to give publicity through many media concerning corporate affairs which goes beyondthe statutory requirements. This practice reflects a commendable and growing recognitionon the part of industry and the investment .community of the importance of informingsecurity holders and the public generally with respect to important business and financial4evelol)ments. This trend should be encouraged * * * " (Securities Act release No.3844 (Oct. 8, 1957)).10~ Anderson, "Corporate Reporting for the Professional Investor: What the FinancialAnalyst ~Vants to Know" (1962) (sponsored by the Corporate Information Committee the Financial Analysts Federation).~o~ One practitioner gave the following definition: "Financial public relations is publicrelations designed to influence the attitudes of the financial community. * * *"

los In the Matter of Carl M. Loeb, Rhoades ~ Co. and Dominick ~ Domin~ek, 38 S.E.C.843 (1959) ; see also I~ ~he Matter-o] G.-J. Mitchell, Jr., Co., Securities Exchange Actrelease No. 6433 (Dec. 13, 1960).


gation of securities markets. The study did not consider it necessaryor feasible to make an exhaustive survey of prevailing corporate prac-tices or of the financial public relations industry generally. It wasinstead determined ’to make an intensive study of the financial publicrelations activities of a small number of companies in order to obtainexamples of differing concepts and practices and to identify currentor emerging problems. For this purpose a questionnaire was mailedto 46 issuers, all of which were believed ~o have conducted significantfinancial public relations activi’ties or whose common stock had ex-treme price fluctuations during the past 2 or 3 years. While the com-panies selected .therefore .are by no means a typical group of publiclyowned issuers, an effort was made to obtain a reasonably broad crosssection from the point of view of size, industry, and principal marketon which .the companies’ common stock was traded. The question-naire 109 sought information concerning fin.ancial public relations ac-tivities by or on behalf of the companies and requested the companiesto furnish copies of certain news releases and reports to stockholdersdistributed during the period under consideration.

After this material had been received and analyzed, five of the com-panies whose activities stood out as demonstrating current or emergingproblems of financial public relations practices were selected for fur-ther study. Trading data and other records were obtained with re-spe~’t to ~hese comp.anies; and company officials, public relations men,brokers, and others were questioned under oath. 11° Another ques-tionnaire 111 was sent to several hundred investors who had purchasedstock of several of the companies, in order to determine the motivationfor their purchases. Additional data concerning ’these and other com-panies, and concerning public relations practices generally were

~athered through an examination of Commission records and by in-ormal interviews with several public relations men, members of ~he

financial press, and securities analysts.The study did not examine the use of publicity in proxy contests.

The financial public rela’tions industry is deeply involved in these con-tests, in ways ’which are frequently a matter of concern to the Com-mission.112 However, it was felt that this area, which is already thesubject of detailed regul.~tion~ 13 presents special problems which are

ao~ A copy is attached as app. IX-B.no The five companies and their principal markets are Avnet Electronics Corp. (NYSE),

tkarChris Construction Corp. (Amex), Chemtree Corp. (OTC), General Develop~ment Corp.(Amex), and Technical Animations, Inc. (OTC). In addition, a certain am(>unt of similardata was obtained with regard to Curtiss-Wright Corp. (NYS~), Guardia~ Chemical, Inc.(OTC), the Lionel Corp. (NYSE), and Universal Controls, Inc. (Amex).

~ A copy is a,i)tached as app. IX~C.~ Commiss.ion concern over publicity techniques in proxy solicitation is reflected in

the following statement by a former Chairman :"A large number of the more difficult problems in any proxy contest result from the

fact that a considerable proportion of the corporation’s outstanding shares are often heldin street names and their ownership is constantly changing. No longer can participantsin a proxy contest rely on being able to communicate with the beneficial owners indirectlythrough the solicitation of stockholders of record. As a result, the use of paid advertise-ments, prepared press releases, press conferences, and radio and television broadcasts, hasbecome common in attempting to reach stockholders and to sway the opinion of the publicand persons who may advise or influence stockholders with respect to giving, revokingor withholding proxies" (Gadsby, "Public Relations Counsel and the Federal SecuritiesLaws." speech made to the New York chapter of American Public Relations Association,New York, N.Y., Apr. 8, 1958).

na Sec. 14(a). of the Exchange Act makes it unlawful, with respect to listed securities,to solicit proxies in contravention of Commission rules; and rule 14a-9 prohibits fal.seor misleading writte~ solicitations. Under rule 14a-6, material used in solicitation mustbe filed with the Commission for comment before it is distributed, except for "speeches,press releases, and radio or television scripts," which must be filed with or mailed forfiling to the Commission "not later than the date such m~tterial is used or published."

REPORT OF SPECIAL STUDY OF SECURITIES :MARKETS 67

beyond the scope of this general survey of financial public relationsactivities.

It is difficult to estimate how widespread are the questionable prac-tices described in this subchapter of the report. There is evidencethat a substantial number of issuers and ’financial publicists have en-gaged in them, and that they pose serious problems. Nevertheless,there is reason to believe that many companies and their publicityagents .conduct their activities in this area ~vith restraint and propriety.The discussion which follows therefore should not be regarded as anexhaustive description of financial public relations activities by Ameri-can corporations, nor should the more questionable activities describedbe regarded as ~ypic~l, even though to the extent that they do exist,they are far from being inconsequential.

2. THE FINANCIAL PUBLIC RELATIONS INDUSTRY

The emergence of financial public relations as a distinct "industry"is of relatively recent date. DeWitt Conklin Organization, Inc., andGartley & Associates, Inc., two of the oldest firms doing only financialpublic relations, entered the field during the late 1940’s. A num~berof other prominent public relations firms are older, but many of theseonly recently began doing financial public relations. During the lastfew years, and especially since 1959, there has been a proliferation ofnew firms 114 Man financial pt~blic relations firms, however, havelost substantial am~Yunts of business since the 1962 market break. Thereason they generally give for this is that most issuers regard theirservices as a "luxury" which can conveniently be forgone when budgetsmust be cut. Another reason may be that corporate publicity, as willbe shown below, has been used to raise security prices; this can ’bedone, however, only to the extent that the general public displays awillingness to enter the market.115

Most financial public relations firms are quite small. DeWitt Conk-lin has 10 account executives; Wall Street Consultants, Inc., has 4;several others, such as Wyle Associates, Inc., and Samuel Weiss &Associates, Inc., are essentially 1-man organizations though manyinclude several writers and assistants depending upon the degree ofsuccess which they have achieved. Some of the larger public relationsfirms today have separate departments to handle financial publicity,and a number of large corporations have employees who specializein communications with stockholders and with the financial commu-nity. General Development Corp., for example, has a director ofcorporate and industrial development whose duties are principallyin the area of financial public relations.

Many financial public relations men have backgrounds as journal-ists or financial writers. 116 According to the financial editor of one

n~ See Financial Publicists Directory for years 1959-62.~-~ See s~c. 3, below.n~ Some practitioners have observed that many unqualified persons have recently entered

the financial public relations field. See McIntyre, "Financial Reporting Has Opportuni-ties," Editor & Publisher, Aug. 18, 1961, p. 42 ; address of Weston Smith to Publicity Clubof Boston, Apr. 4, 1962 (reprinted in Commercial & Financial Chronicle, May 3, 1962, p.25~. These observations may be true, but most of the financial public relations men inter-viewed in the course of this study had journalistic or financial experien.ce, or both. Anotable exception was the account executive of the firm representing one issuer, who hadno background or experience in the financial field and who was selected for the job becausehe was the only male in the firm, which generally specialized in using public relations tohelp people who wished to be accepted into "society."


New York newspaper, the loss of staff men~bers to the more lucrativefinancial public relations field is a constant problem., Experience andfamiliarity with financial writing are, of course, valuable assets to anyfinancial public relations man. There is, however, another reason whyfirms draw their talent from the financial press: personal associationsand contacts are of great importance in this field. One practitionertestified~ "Contact is an important part of our business, and the morecontact you have, the more valuable your organization becomes."Many firms, in their selling literature designed for prospective clients,emphasize that their close working relationship with the financial pressenables them to "place" articles concerning their clients in the. financialpages of newspapers.and magazines. Bozell & Jacobs, Inc., claims that

has continuing p~rsonal contact with ,the people who write for and who editfinancial news magazines and papers, as well as weekly news magazines andbusiness and trade publications * * * Constant contact is maintained withthe editorial personnel of investment and financial magazines. It is generallypossible to place newsworthy material with these media for publication,n~

Other financial public relations men are former securities analysts.Personal contacts and associations with those who write and distributeinvestment advisory material are also considered important by thefinancial public relations industry. One practitioner states that thefact that his firm includes members of the New York Society of Se-curity Analysts is a talking point with clients.

Fees charged by financial public relations firms vary greatly. Sometirms that merely write news releases and perhaps a~d their clientsin the preparation of annual reports charge as little as $250 per month.On the other hand, one firm charged as .much as $6,000 a month fora variety of services~ probably including some that cannot be classi-fied as financial public relations. The average fee for complete finan-cial public relations service, including .preparation of reports to stock-holders and news releases, arranging of addresses before analysts’groups, and general maintenance of contact with the financial pressand-the investment community, amounts to between $1,000 and $1,500per month. Most contracts for public relations services also providefor the payment of expenses for printing, mailing, entertainment,travel, and similar items.

Some financial public relations firms receive all or part of theircompensation in options to purchase stock of their clients. Thispractice can be criticized on the ground that it gives the publicist anincentive to try to increase the price of the client’s stock rather thanto disseminate unbiased corporate information. The results of thisstudy ....indicate that, while the’practice of pya ingpublicists’ fees inoptions is not prevalent, st nevertheless does exist. Of the 46 companiesthat received questionnaires, only 5 had paid their financial publicrelations firms wholly or partially in stock options. It is the policy ofsome firms not to accept options so as to avoid any conflict betweentheir interest in monetary gain and their obligation to disseminatehonest publicity. Other firms defend stock options on the groundthat they enable small and little known companies to obtain the servicesof firms which they could not otherwise afford.

n¢ Bozell & Jacobs, Inc., "An Estimate of Financial Relations," pp. 5-6.

REPORT OF SPECIAL STUDY OF SECURITIES IVIARKETS 69

It is not unusual for public relations men to trade in the securitiesof their clients, acquired either through the exercise of options, pur-chase from the company or corporate insiders, or purchase on theopen market. During 1961 the principals in the financial public rela-tions firm of Wall Street Consultants, Inc., had personal transactionsin the securities of 6 of the firm’s 18 clients. Samuel Weiss, althoughhe has stated that trading by public relations firms in the securitiesof their clients is an abuse that should be regulated, has acceptedstock options as a fee from at least one client, Harvey Stores, Inc.These options were never exercised, since the price of the stock wentdown. Weiss also purchased $30,000 face amount of BarChris con-vertible debentures at the offering in May 1961 and sold them shortlyafterward at a profit of 12 or 13 points. During this time, Weiss waspreparing and issuing publicity releases and reports on behalf of Bar-Chris. Harold Wolff, public relations consultant for Technical Ani-mations, Inc., received options to purchase 15,000 shares of the com-pany’s stock at a price of $2,375 and 10,000 shares at $3,453, in pay-ment for his public relations services for 2 years. In April 1961an article concerning the company appeared in Time magazine andthe stock rose sharply. Shortly after the appearance of the article,Wolff exercised options to purchase 1,700 shar~ which he sold onthe market at prices ranging from 93/~ to 113~.11s

So far as is ..known to the Special Study, the most active traderamong public relations men was Jerr~¢ Finkelstein, president of the~)ublic relations firm of Tex McCrary, Inc., until its dissolution ir1Yfay 1961. Finkelstein purchased 20,000 shares of the common stockof Universal Controls, Inc. (then called Universal Products Co., Inc.),in April 1958 in a private sale for $500,000. During 1959 and 1960,while Tex McCrary, Inc., acted as public relations consultant forUniversal Controls, Finkelstein sold almost all of these shares on theop(m market for a total consideration of approximately $2,600,000.In April 1958, Finkelstein also purchased 15,000 shares of the commonstock of General Development Corp. (then called Florida CanadaCorp.), another client of the firm, at a price of $9.50 per share. Thestock closed at 14% on the American Stock Exchange on the date ofthe purchase. In May 1961, after General Development had ceasedt.o be a client, Finkelst~in sold just under half of l;hese shares, pur-chased for $70,300, to the Oppenheimer Fund for $263,625. Both ofthese blocks came to Finkelstein’s attention through an individualwho was a principal stockholder, director, and officer of bothcomp,anies.

The above examples of trading by public relations men in the securi-ties of their clients are set forth not to imply manipulative or anyother improper intent on the part of these persons, but only to dem-onstrate the conflicts of interest present in such sitttations. Since thepublicists are under no obligation to disclose their financial interestsin issuers, neither the press, the financial com~nunity, nor the publicmay be aware that corporate information which they receive comesfrom an interested source.

Several firms not only do financial public relations, but offer thei:clients a variety of other services which are generally termed "finan-cial consulting" or "management consulting." These services include

l~s See see. 3, below.


advice on the composition of boards of directors, assistance in negoti-ating mergers or acquisitions, and finding of new firmncing. Onepractitioner grossed approximately $100,000 in finders’ fees during1961 and 196g for arranging underwritings and private placementsof securi6es, acquisitions of companies or product lines, and businessleases for his clients.

Some financial public relations firms apparently have informalarrangements with underwriting firms whereby the underwriter rec-ommends the public relations firm to issuers and the public relation~firm reciprocates by bringing the underwriter together with Chose ofhis clients who are looking for new financing. For example, WyleAssociates, Inc., a public relations firm retained by Avnet ElectronicsCorp., arranged for Hemphill, Noyes & Co., to underwrite an issue ofsecurities for Avnet. Subsequently, partners of Hemphill, Noyes whowere members of the boards of_directors of ocher publicly held com-panies were instrumental in Wyle’s being retained as public relationsconsultant by these companies.

Samuel Weiss, who also has such reciprocal arrangements withunderwriters, was paid for his services on behalf of BarChris Con-struction Corp. not only by the client but also by its original under-writer, Peter Morgan & Co., which had recommended him to thecompany. The compensation from Morgan consisted of warrants topurchase 900 shares of BarChris common sto~k at $3 l~r share. W~issexercised these warrants in early 1962, when the market price of thestock was $9.

3. PUBI,ICIT~ AND SFM3URIT~

It is hardly open to question that corporate publicity can have apowerful effect on the prices of securities. By virtue of his accessto the financial press and investment advisers, the financial publicrelations man often has the ability to increase (or decrease) the mar-ket prices of the securities issued by his clients.

Members of the industry who were interviewed in the course of thisstudy denied that their purpose was to affect prices. One practitionerstated the general attitude as follows:

I don’t think any program should be tied to the price of the stock. I thinkanybody in financial public relations who does anything to affect the price ofthe stock is treading on a very fine line of what is right and what is wrong.

Financial public relations men insist that their principal purpose isto disseminate the facts concerning their clients so that they willbecome better known to the financial community and will thus bein a better position to obtain new financing. Without an effectivepublic relations program, one corporate official states, "We might bedoing the best work in the world and nobody would know about us." 119

Nevertheless, in their selling literature aimed at prospective clients,financial public relations men emphasize that one effect of a financialpublic relations program will be to increase the pric~ of a company’scommon stock. They point out that the communication of a com-pany’s "story" to its stockholders and the investing public will resultin a "full capitalization," "equitable evaluation," or "more realisticmarket appraisal" of the company’s securities; and they state that

~ See Mellott, "Whys and Wherefores of a Public Relations Program," Commercial &Financial Chronicle, Dec. 29, 1960, p. 20.


companies that are well known to the financial community generallyhave a higher price-earning ratio than obscure companies of the sameworth.12° Whatever words are used, little doubt remains that theirpurpose is to increase stock prices. Indeed, some financial publicrelations men concede that they are salesmen of their client’s stock.For example~ one practitioner testified:

The end result of our service is that people would be interested in the company

~~e ha~en desire, possibly, to buy their stock. This is no different than whate been doing for 10 years before, when we sold products. We create afavorable image.

In outlining the services which he would l~rform on b~h~lf ofBarChris Construction Corp., Samuel Weiss wrote:

It shall be the function of our office to interest significant brokers and under-writing houses to take a position in your company’s stock, to foster sustainedinterest and, therefore, widen stock distribution.

Another financial publicist testified as follows:Q. What is your purpose in sending releases to analysts?A. I suppose you might say that we are generating an investment interest--

investor interest, I might say--in the company.

Public relations firms promise their clients several advantages asa result of an increase in the price of their securities. The companywill be able to obtain more favorable terms in any exchange of stocknecessary to an acquisition or merger; future financings will be facili-tated; stock options will have ~ greater value as incentives for man-agement and as a means of granting competitive compensation; andthe company will be bett~r protected against proxy fights and r~ids.I~1The emphasis which the firms themselves place upon these incentivesindicates that they believe them to be significant as a persuasive factor.

It cannot be ignored that, in addition to these corporate incentivesto increase stock prices~ members of company managements who ownstock or options have a strong personal motive. Insiders of a few ofthe companies that were studied sold large amounts of stock at approxi-mately the time of an intensive public relations effort. For example~between February and April 1961, the president of BarChris Con-struction Corp. and his wife sold 10,800 shares of BarChris stock, andthe company’s executive vice president sold 6~900 shares; 122 imme-diately before and during this period the company was disseminatingextremely optimistic financial estimates and enthusiastic publicityconcerning its alleged expansion into the European market. In Apriland May 1961, Alfred Globus~ president of Guardian Chemical, Inc.,and a corporation 100-percent owned by Globus, together sold 19~414shares of Guardian stock. During this period, Globus was announcing

~o See, for example, Bozell & Jacobs, Inc., "An Estimate of Financial Relations" ; bulletinon "Corporate Relations," published by New York Society of Security Analysts; Busch,"Corporations Must Promote Financial Public Relations," Commercial & Financial Chron-icle, Mar. 23, 1961, p. 14.

~ See sources cited at no.re 120, above. The Albert Frank-Gunther Law, Inc., programfor one client stated:

"The long-term purpose * * * is to create an ever-increasing receptivity in the financialcommunity to [your company] so that a more equitable evaluation of the company’s securi-ties will resuIt in the marketplace. This is vital to [your company] for a number ofreasons, the most important of which are : (1) The need to be better known and recognizedin advance of any future financing, in order to obtain money as cheaply as possible, and(2) to enable the company to get more favorable terms in any exchange of stock necessaryto an acquisition or merger."

~ These sales were made on the American Stock Exchange at prices ranging from 13~to 22~. The stock had closed at 10a~ on Dec. 1, 1960 (prices adjusted for 2 to 1 split).The ris~ in price was probably caused in part by the public relations campaign describedin sec. 5, below.


to security analysts and the press that a chemical developed by Guard-ian constituted a "breakthrough" in the chemical treatment of cancel’.Guardian common stock rose from 2y~ on April 3, 1961, to 143A onMay 16, 1961. By June 30, 1961, it was down to 53~ ; and by June 29,1962, ~o 2~.123 Whether or not these insiders wer~ motivated bythe opportunities for profit when they authorized the releases of pub-licity by their companies, they clearly benefited from the increasedprices that the pubhcity helped produce.

One of the most notorious recent examples of the use of financialpublicity for purposes of personal gain was an attempt to depress theprice of a security in order to cover a large short position. In June1958, Alexander Rittmaster, financial consultant to Louis E. Wolfson,told a New York Times financial reporter that Wolfson and membersof his immediate family were in the process of liquidating their hold-ings of some 400,000 shares of American Motors Corp. common stock,representing some 7 percent of the then outstanding stock. An articlequoting a "spokesman" of Wolfson to this effect appeared in theTimes on June 20, 1958.124 In fact, by this date, accounts in whichWolfson or members of his family had an interest had already sold464,100 shEres and had acquired a short position of 172,400 shares.On Friday, June 20, American Motors fell 1/~ point to 121~ on a re-ported volume of 92,000 shares, and on Monday, June 23, the s~ck fellto 115~ on a reported volume of 113,400 shares. On these 2 days,accounts in which Wolfson had an interest purchased 40,400 shares tocover short positions. Speedy injunctive action by the Commissionhad the effect of forcing Wolfson to disclose the true facts and delay-inghim from further covering his short position.125

The Wolfson incident demonst.rates-the effect that a single pieceof publicity in a single newspaper can have on trading in a security.A skillful or lucky publicist is sometimes able to use one article orother item to generate others in a kind of snowballing effect. For ex-ample, Clement Wyle, public relations man for Avnet ElectronicsCorp., was able to interest the financial department of the New YorkTimes in publishing a feature article, on December 29, 1960, about aclass of schoolchildren who owned two shares of Avnet stock and whoattended the company’s annual meeting. A writer for Investors’Reader, a magazine published by Merrill Lynch, Pierce, Fenner &Smith, noticed the New York Times article, and became interested inwriting a report on Avnet; Investors’ Reader, ~vhich is mailed to ap-proximately 200,000 Merrill Lynch customers, ran an article aboutthe company March 29, 1961. Avnet subsequently sent copies of theissue of Investors’ Reader to all of its stockholders.

Perhaps the clearest demonstration in the course of this study ofthe .a.bilit.y of publicity to affect the price of a security, and of thedangers inherent in this ability, occurred where the publicity ap-parently was not generated by the issuer or its public relations man.The issuer was Technical Animations, Inc., a small company whichowns the rights to a process by which animation or motion can be

~:a Unless otherwise indicated, all prices of stocks traded over-the-counter are the highestbids reported by the National Quotation Bureau.

~ According to Rittmaster, ~rolfson was selling the stock because he planned ta de-vote more of his energies to his duties at Merritt-Chapman & Scott Corp. Immediatelyafter the article appeared, Wolfson was reported to have told a press conference that thefigures quoted by his "spokesman" were "inaccurate." The effect of these remarks probablywas to confirm the overall impression of the article.

~5 ,~.E.C.v. Louis E. Wolfso~, U.S.D.C., S.D.N.Y. cir. file No. 135-30.

REPORT OF SPECIAL STUDY OF SECURITIES :MARKETS 73

added to a slide or transparency without the use of conventional ani-mation techniques. From the time of its incorporation in 1956 throughthe period under consideration, the company did not operate profit-ably in any year. For the year ending October 31, 1960, it had salesof approximately $367,000 and a net loss of $65,000. In the early partof 1961, its outstanding stock consisted of 200,000 shares of class Avoting common stock and approximately 400,000 shares of class Bnonvoting common stock. Officers and directors of the company heldapproximately 59 percent of the outstanding class A stock and ap-proximately 19 percent of the class B stock. On March 31, 1961, theclass B stock was priced ’at 4~/~ in the over-the-counter market.

Early in April 1961, Joseph Purtell, s~nior editor in charge of thebusiness-news section of Time magazine (he is no longer with Time)telephoned .the company and expressed interest in it as a possible sub-ject for an article in Time. According to Purtell’s testimony, he hadfirst heard about the company from his broker, Benjamin Weiss, apartner in the New York St~ck Exchange member firm of Wineman,Weiss & Co., who hud suggested that Technical Animations might bean interesting company to look into. Purtell subsequently had aninterview with Harold Wolff, the company’s public relations man, whodemonstrated the company’s process to him. On April 13 and 14,Purtell purchased 2,500 shares of Technical Animations B stock at

~r~rteCeS of 6~ ~ 63/_4 through Win_eman, We.iss & Co. On April 1.811 assigned a Time writer and a researcher to prepare an articleon the company. Between April 13 and 21, Weiss purchased 1,500shares for his own account and an additional 4,500 shares for 4 of hisregular customers at prices of 61~ to 73/~. By this time, word hadleaked out in financial circles that Technical Animati.ons was expectedto be written up by Time, and on the basis of these rumors registeredrepresentatives of at least two brokerage houses were recommendingthe stock to their clients. 126 The full extent of the circulation of therumors is unknown.

Apparently, as a result of these run~ors and the consequent increasein the volume of trading, the price of the stock~ which had beenon April 19, rose to 7~/~ on April 21 and 91~ on April 24. The articlea~)peared in the business-news section of the April 28, 1961, issue ofTime, which became available on the Nation’s newsstands late in theday on April 24, and on April 25. The stock continued to rise~ reach-101/s on April 25, 12 on April 26, and 13~/~ on April 27. On tha£ day,Technical Animations shares were purchased by members of the pub-lic for as much as 151/s. During the first 3 days after the article ap-peared, Weiss and his 4 customers sold 4,700 shares, officers of thecorporation sold 2,400 shares, and its public relations man sold 1,300shares (acquired through the exercise of options), at prices from 93/~to 13~./4. The public relations man sold an additional 400 shares on.May 3 at prices from 105~ to 11. On the following day PurCell sold1,000 shares at a price of 115~. By May 31 the stock was down to 8a/~.Purtell sold his remaining 1,500 shar~s on October 26~ 1961, over 6months after purchase, at a price of 5~./4.127 On December 31, 1962,Technical Animations class B stock was priced at

~2~ Six purchasers who were sent questionnaires by the Special Study replied that theirbrokers had told them that an article concerning Technical Animations would appearin Time. Two of these brokers were questioned under oath. One stated that he heardabout the impending article from somebody to whom he gave a lift downtown in his car,while the other heard about it from a fellow broker who had been told about it at aparty in Newark, N.J. Neither could remember the name of the informant.

~27 A chart of the price of Technical Animations stock during April and May of 1961is attached as chart IX-e.

96746 O---63--pt. 3------6

CHARZ IX--e

TECHNICAL ANIMATIONS, INC. Class "B" Common StockApril - May l?61 ¯

i

DAILY Hi6H BiD

I I I I | I I | I I I ! I I I I I I I.,1 4 $ . d, ? 10 IS 13 t) l,~ l? ~8 l~ 3~ 3| 24 3S ~ 37

APRIL

I l I I I I I I I ! I I12 IS L6 17 H 19 22 2,1 24 25 ~5

MAYEo~tem Stock ,~"~o~, Notlonol Daily Ouotat~¢¢~ Service, ~ub~,l~h~d by Nat,/o~l Quolatlen B~f’~au~ In¢,

REPORT OF SPECIAL STUDY OF SECURITIES I~IARKETS ~

It is clear that the Time article was the principal cause for the risein the pric~ of the stock. Questionnaires were sent to approximately300 customers who purchased the stock in April and May 1961, inorder to determine their motives for investing. 12s The article was thedetermining factor for 101 customers out of a total of 160 who re-turned questionnaires and who made purchases after its publication.It is likely that many of the other 59 who stated that the stock was rec-ommended to them by friends, acquaintancess or brokers were in-directly affected by the article in Time. _

There were a number of reasons for the impact of the article. First,the article was unduly favorable~ stating that the company’s "salesh’ave risen in 5 years from $7s000 to $600~000 this years" and that it"went into the black" in 1961. Sales for the year ending October 31,1961,. totaled approximately $450,000 ands although the company hadearmngs in one quarter of 1961, it had ’a small net loss for the year.Secondlys the volatility of the stock was undoubtedly increased by thefact ,that the country was in the midst of a speculative bull market;also, stocks of companies in the photographic and related fields wereparticularly popular with the investing public at the time. A thirdreason for the dramatic price rise was the smallness of the floating sup-ply of the stock. The purchase before the publication of the articleby persons who knew of the impending article contributed to the de-mand for the stock which helped to push the price up. Their saleof these shares shortly after the publication of the article no doubtcontributed to and hastened the stock’s rapid descent.

Technical Animations was not the only company in whose stockPurtell s Weiss, and Weiss’ four customers had transactions of this na-ture. B~tween August 1957 and April 1961~ Purtell had transactionsin ’the securities of 64 companies, of which 27 were written up in thebusiness-news section of Time. In each of the 27 cases he purchasedthe stock a few days or a few weeks before the date of the publicationof the article concerning the particular company and he usually soldthe stock within a few days following the date of publication. Asubstantial number of these companies were small and little known.In generals Purtell held the shares of companies not written up inTime for a longer period. He made a considerable profit from tradingin stocks of companies that were written up in Time~ since in mostcases the price of the stock rose sharply upon the publication of thearticle or shortly before. PurtelFs average purchase was about 1,000sharess but in some cases he purchased considerably more, the largestpurchase being 2,500 shares. His investment in each security was usu-ally about $20s000, and on a few occasions it exceeded twice thisamount. During this entire period Purtell was the business editor ofTime. These transactions s which constituted a substantial part ofPurtelFs total trading, ceased abruptly at the end of April 1961, whenPurtelFs employment at Time terminated.

Purtell didall of his trading through Wine.man, Weiss & Co. In thecase of 16 of the 27 transactionss Weiss also purchased stock immedi-ately before the article appeared and sold soon after~vard. Pur-t~ll testified that prior to a number of these transactions, he mayhave discussed with Weiss the possibility that Time would publish an

See app. IX-C.

76 REPORT OF SPECIAL STUDY OF SECURITIES ]gIARKETS

article about the company. Weiss’ four customers made similar trans-actions on several of these occasions.129

Purtell testified to the Special Study that he knew of no policy.atTime which prohibited him from purchasing securities of companmsabofit to become the subject of articles in Time. According to the edi-tor-in-chief of Time, such a policy has existed since the magazine wasfirst published, and any detected violation of it would have meant sum-mary dismissal. The editor-in-chief further stated that Purtell’sviolations were not detected.1~°

IR the course of this study, many additional instances were foundin which corporate publicity appeared to have a direct effect on pricesof securities. For example, on December 16, 1960, Samuel Weiss &’Associates, Inc., public relations consultant for BarChris ConstructionCorp., and Edward Gottlieb & Associates, public relations consultantfor Acme Missiles and Construction Corp., distributed 600 copies ofa release to the business and financial press and 4=30 copies to researchdepartments of brokerage houses, trade publications, and sports edi-tors of New York newspapers~ announcing that the 2 companies hadformed an Italian subsidiary for the purpose of constructing and oper-ating a series of bowling centers in Italy and other European countries.BarChris stock, which had closed at 23 on December 15, rose to 24=¼on December 16, to 251//2 on December 19, and to 267./8 or~ December 20.An even clearer example of the effect of publicity on prices is Chem-tree Corp., whose common stock rose from e/~6 of a point on December4, 1961, to 9~2 on January 3, 1962, upon the announcement that thecompany had developed a new material for use as a shield againstfallout radiation. By June 30, 1962, Chemtree stock had fallen to $2.

There are limits, however, on the ability of publicity to affect marketprices of securities. A company whose claims and predictions for it-self remain repeatedly unfulfilled, may, like the boy who cried "wolf,"end up by being ignored. In February 1961, the public relations firmretained by the Lionel Corp. conducted an informal survey of WallStreet brokerage houses in order to find out how Lionel was regardedby the financial community. Some of the brokers’ comments are ex-tremely revealing as to the negative effects of an overenthusiasticpublic relations program. One broker’s comment was :

Right now, Li~)nel is selling for more than its earnings justify. Before it cango up again, Roy Cohn or General Medaris must pull a new rabbit from the hat.If this does not take place, the stock will go down below t.he price it should sell at.The reason for .this is that much of the demand which caused the rise was basedon hope. If the hope dies out, the buyer will remember only his disappointment,and he will sell regardless.

We are staying out of the stock because there is t~o much news about thingsthat then do not take place. I am not saying that any of these rumors originateswith Lionel officers ; they do affect the stock by making it too volatile for ’anyonebut a floor trader to own. One of our account executives was foIlowing Lionel

~ The 4 customers h~d transactions, respectively, in 20, 6, 5, and 3 of the 27 stocksat approximately the same t’m~e as Purtelrs tra~nsactions.~u0 A written statement reflecting such a policy, which was distributed to Time em-ploye~s ~n June 6, 19.61, stated in part :

"Profiting from spec{al informa$ion.--It has been a lo.n.g~taneting point of policy thatno employee of Time, Inc., should try to pr,(>fit (by buy,ing o.r selling securities or other-~vise) from special inf~rm&tio~ that one of our magazines plans to carry a ~tory or pictureon a company. In tlm very unu,sual case of a staff meqnber wh~ hold~ a.’significan~interest l~ a company and who might be assigned to w(>rk o.n a story about that c(~mpany,his personal interest should be referred to the man~gln~" ed~o~- or his supervisor Inadvance."

REPORT OF SPECIAL STUDY OF SECURITIES I~ARKETS 77

closely, but .the information he got contradicted itself so often that the partnerscalled him in and told him to let it go. [Emphasis in original.]

Another broker said:What I don’t like is that we hear from time to time [an] acquisition is going

to be made, and then we hear it is not. Simply having plans for good purchasesis like you ~)r I think about buying a stock .that will go up in price. Everybodyis thinking ; the trick is to get it~ [Emphasis in original.]

Corporate publicity can be used to accentuate but ordinarily not toreverse a market tre~d. For example, one public relations mantestified :

The main thing, you can never buck a market trend. * * *Q. But if there is a market trend in your favor, you can accent i,t?A. Very definitely.

There can be no doubt that its potential upward effect on prices isgreatest during periods in which the public is already infected withspeculative fever and is eager to purchase securities. The publicityconcerning BarChris referred to above came at a time when the bowl-ing industry enjoyed great .popularity with investors. A year later,when the interest in bowling companies had subsided, equally optimis-tic publicity which was distributed by the company did not reverse adownward movement in the price of its common stock. Likewise, theeffect of Chemtree’s publicity was no doubt increased by the FederalGovernment’s announcement of the inauguration of a fallout shelterprogram and the public concern with protection from radiation whichwas in evidence in late 1961 and early 1962.

Material appearing elsewhere than in financial publications or onthe financial pages of newspapers and n~agazines may have an influenceon security prices. According to one financial public relations man:

You can actually influence the public to a much greater degree by having storiesappear on other pages than the financial pages. Believe me, a story in Life maga-zine, Reader’s Digest, can do more than 50,000 pages on the financial page * * *If you distribute enough pencils with your name on them, it will influence theinvestor. He is not very bright.

The distinction between financial and product public relations is notalways an easy one to draw. Publicity ’and advertising normally.re-garded as having the purpose of selling a company’s goods or servicesmay also affect the prices of its securities. For example, on February23, 1961, General Development Corp. ran a full-p’age advertisementin the Wall Street Journal, the New. York Times~ the Chicago Tribune,and the Philadelphia Inquirer~ describing the company’s home-pur-chase plans at Port St. Lucie on the east coast of Florida. Its stockwas the most actively traded on the American Stock Exchange on theday that the advertisement appeared, and it rose in price from its pre-vious day’s close of 121~ to 14’1/~. By February 27, however, it hadfallen back to

Conversely, the channels of financial public relations can be used forselling ’a company’s products and for other business purposes.1~1 Be-tween March and May 1961, the president of Avnet Electronics Corp.addressed the New York Society of Security Analysts, as well as a

~1 Accordiag to one writer, good corporate publicity will help sell a company’.s products,"becau.se it’s only natural, when a choice is offered, to favo~ the proctucts of those com-panies we like and in wh.ose stock we have invested." B~lsch, "Corporations Must PromoteFinancial Pttblic Relations," Commercial and Financial Chronicle, Mar. 23, 1961, p. 14.

78 REPORT OF SPECIAL STUDY OF SECURITIES I~IARK~TS

smaller group of New York security analysts specializing in electronicsstocks and groups of analysts in Chicago and Los Angeles; he wasinterviewed by many_ individual analysts; and the company mailedto all of its stockholders copies of favorable reports on Avnet whichhad been prepared by two large brokerage firms. According to thepresident~ he was not concerned with the price of the company’s stock,but he hoped to utilize the connections that some security analysts hadwith officials of major corporations in order to interest them in be-coming licensees of the Shaw process, a method of casting metals ofwhich Avnet owned the Western Hemisphere rights. Regardless ofthe president’s intentions, the stock rose from 187,/s on March 1, 1961,to 681~ on May 8, 1961. He concedes that this phenomenal rise wasat least in part a result of the enthusiasm of the analysts which heplayed a part in generating. By the end of the year, the stock wasdown to 281/~. Similarly, the president of Chemtree Corp. claims thathis aim in seeking to persuade the financial press to write about thecompany’s radiation-shielding material was to acquuint the publicwith it and to obtain licensees to produce it.

As these cases sbow~ the motives underlying public relations activi-ties may be of several kinds or may be mixed. In a given instance~the primary purpose may be to sell the company’s products, increaseits prestige in the financial community, increase the price of its stockfor a future financing or merger, or a combination of these.132 Theessential point is that the investor who relies on publicity that is over-enthusiastic or incorrect may be injured, regardless of the purposeof those who are responsible for it.

4. ~I~rHODS OF OPERATION

Many of the techniques and methods which the financial publicrelations industry uses to accomplish its purposes may be illustratedby a program mapped out for General Development Corp., a Floridaland development company whose common stock is traded on theAmerican Stock Exchange. This program was submitted by_JohnF. Bonner, who was responsible for the company’s financial publicrelations~ to the officers of the company in January 1961, and a largepart of it was subsequently carried out. Very few financial publicrelations campaigns include every activity suggested in Bonner’s"proposed program," but it has the advantage of illustrating alm.ostall of the techniques employed by financial publicists in recent years.

The program was divided into three parts~ dealing respectivelywith relation with the investment community, relations with the finan-

~cial press, and relations with stockholders. Under the first heading~Bonner recommended the following activities:

(1) Groups of security analysts should be invited to Miami andto the company’s properties on a series of field trips.

(2) Senior partners of the investment firms which "can do us themost good" should be invited individually on similar field trips.

(3) A series of luncheons for small groups of investment peoplein New York and other northern cities should be arranged~ at whichofficials of the company would speak and answer questions.

~a~ Anotl~er m(ytive for seeking to obtain l~ublicity is egotism on the part of corporateofficers. A public relatt(rns man states of one such in&ivl4ual : "He loved to see his namein print, whether it be on the financial Imge or the woman’s pa~, or whatever page itm2v b~’~

REPORT OF SPECIAL STUDY OF SECURITIES 1VIARKETS 79

(4) Luncheon or dinner meetings with Florida securities men shouldbe held at least semiannually.

(5) "Top investment people" visiting Florida should be invited the company’s properties.

(6) "Pressure" should be placed upon the New York Society Security Analysts to obtain a speaking date for company officials.

(7) Similar "pressure" should be brought to bear on analysts’ so-cieties in other northern cities.

(8) An attempt should be made to get company officials on "otherkey programs" such as the annual meeting of the Investment BankersAssociation.

(9) Four of five of the best market advisory services should persuaded to visit the company’s properties.

(10) Full use should be made of members of the company’s boardof directors who have achieved stature in the financial community.

(11) An effort should be made to obtain speaking engagements~vith leading investment groups.

(12) More frequent trips to New York City should be made "in theinterests of fence mending, arousing interest, answering current ques-tions, etc."

The program recommended that the following steps be taken underthe heading of "Relations With the Financial Press" :

(1) More frequent financial press releases, such as releases on vari-ous aspects of the annual report before the report is published, shouldbe issued.

(2) There should be better advance planning for the purpose timing "financial-type" releases "more conveniently."

(3) "Pressure" should be applied to get one or more of the "verytop people" of the Wall Street Journal to visit the company’sproperties.

(4) A series of luncheons for small groups of members of thefinancial press should be held in New York and other northern cities.Company officials should not let any visit to New York go by withoutgetting together with "key financial newsmen."

(5) Full use should be made of company officials with nationalreputations in setting up interviews or holding luncheons with financialwriters.

(6) Attention should .be paid to finding outlets for the company’s"corporate story" on other pages than the financial pages of news-papers, such as the women’s page.

(7) A greater effort should be made to "place" stories of a technicalnature in professional magazines such as banking and accountingpublications.

(8) Company officials should make more frequent trips to NewYork and to other cities for "fence-mending contracts with the finan-cial press."

(9) A.policy should be devised for making a fast andfull answerto any rumors which may hurt the company.

(10) Efforts should be made to interest financial editors of theFlorida. press in the company.

Under the heading of "Relations With Stockholders," Bonner madethe following recommendations :

(1) A letter should be sent to stockholders giving preliminaryfigures on the "upturn of business" in the fourth quarter of 1960.

80 REPORT OF SPECIAL STUDY OF SECURITIES I~ARKETS

Unless the company was willing to make regular quarterly reports,however, this letter should be "disguised" as a news iten].133

(2) A stockholder’s magazine or newsletter on a monthly basis quarterly basis should be published.

(3) The company should look into the advisability of holdingregional stockholders’ meetings which might take the form of lunch-eons in three or four key cities, such as New York, Philadelphia, andChicago.

Bonner also recommended that the company run a series of "cor-porate image" advertisements which would "tell the General De-velopment Corp. story in terms of customers, community growth,assets and other financial growth, economic impact on Florida, utilitypotential, how we differ from other land companies, what the stock-holder owns in the way of equity, etc." These advertisements would beplaced in the Wall Street Journal, Business Week, Barrons, andother financial publications. The program also recommended thatWyle Associates, Inc., a New York public relations firm whose con-tacts "appear to be exceptionally good in the financial and invest-ment fields," be retained "to help put into effect during the comingyear the various aspects of a full-scale corporate image program.* * *"

As the General Development program indicates, financial publicrelations men expend considerable effort on maintaining and improv-ing their relations with security analysts. This is often done witha view to obtaining favorable mention of their clients in investmentadvisory material. Several instances were found in the course of thisstudy in which publicists or corporate officials actually participatedin the preparation of market letters which were distributed to thepublic as impartial investment advice, beyond checking for factualaccuracy. For example, in the spring of 1961, Hemphill, Noyes & Co.prepared a detailed report on General Development Corp. and sub-mitted it to the company for its comments. Several General Develop-ment officials worked on the draft, and an 11-page report containing28 detailed suggestions and changes was sent back to the brokeragehouse; along ~vith the notation that most of these comments--involve no corrections, but changes in wording or additions that * * * wouldadd body, meaning, and overall understanding to your presentation.

A few weeks later, the research partner of Hemphill, Noyes replied:I have made all of the suggested changes and hope that it now meets with

your approval.

The 8-page report, which gave a very favorable view of the company’sprospects, was distributed to Hemphill, Noyes customers in July 1961,at a time that a registration for the public offering of 162,500 sharesof General Development stock was pending before the Commission.Hemphill, Noyes was not a participant in the underwriting, and theresearch partner of the firm testified that he was not aware of itspendency.

There are other examples of publicity agents writing material whichis sent to customers by brokerage firms. For example, in January1962, a public relations man retained by Chemtree Corp. helped write

~aa Under the new policy of the American Stock Exchange, inaugurated in 1962, com-laanies seeking now listings of securities are re(luired t(~ file quarterly financial reports.See also ch. IX.B.1, above.

REPORT- OF SPECIAL STUDY OF SECURITIES 1VIARKETS

a market letter of the brokerage firm of Hanson & Hanson which n~adeseveral extravagant claims for the company’s alleged ne~v radiationshielding material.

DeWitt Conklin Organization, Inc., a financial public relations firm,prepares a "report" for each of its clients, which usually consists of a4- or 6-page illustrated folder describing the client company, its securi-ties, its management, and its prospects. These reports emphasizefavorable information and may include highly optimistic projectionsof sales and earnings. DeWitt Conklin sends these reports to a masterlist of 18,000 members of the press, security analysts, and financialwriters, together with an offer to imprint the name of the recipient’sfirm on the top of the front page of 500 or more additional copies ofthe report, at the expense of the issuer. A brokerage firm can thus,without cost to itself for research or printing, send out reports onDeWitt Conklin clients with the brokerage firm’s name prominentlydisplayed. These reports bear a legend in small type that :

This report is released and distributed for and on behalf of the companyin the interest of developing closer relations among the company, its stockholders,and the financial community. The information contained and any opinions ex-pressed in this report are solely those of the management of the company.

Nevertheless, it is likely that the format of these reports leads manycustomers receiving them to believe that the brokerage firm is respon-sible for them. It is not unusual for 50 brokerage firms to request anaverage of 900 copies of a report to be-imprinted with their firm names.

Personal contacts, both with the financial press and the investmentcommunity~ are the very essence of financial public relations. In theirselling literature, financial public relations firms emphasize the close-ness of their contacts with financial writers and analysts. One firminforms prospective clients of its--systematic meetings of individual * * * staff members with the press, |ndividualse~.urity analysts, investment counselors, security dealers and portfolio managersof banks, insurance companies, and mutual funds to keep them informed of[the client’s] efforts and activities. This personalized approach has been mostimportan.t in the building of specific interest in our clients companies.

Another firm promises to--make regular personal calls upon the more important bankers, brokers, invest-ment services, and othed financial opinion leaders, as well as the security analystswho specialize in [the business of the client].

One of the largest public relations firms employs an ex-newspapermanprincipally for the purposes of maintaining friendly contacts with thefinancial press and "placing" articles concerning the firm’s clients.This individual testified as follows:

[A]s they say in my business, it is 50 percent what y~>u know, 50 percent whomyou know. I think a better average would be 80 percent whom you know.

The importance of personal contacts and associations is illustrated inthe case of General Development Corp. In January 1961, Bonnerinvited Nicholas Crane, a member of the sales department of DeanWitter & Co. and a former president of the New York Society of Secu-rity Analysts, to assist the company, in its public-relations program.Crane used his contacts with security analysts at several brokeragehouses to invite them on the company’s behalf to visit its Florida prop-erties. Crane also arranged for the society to extend an invitation tothe company to address one of its luncheon meetings. Crane received


no compensation for these services, but he hoped (in vain) to be re-warded by receiving some brokerage business from the company’spension fund, and to interest the company in purchasing a tract ofFlorida land, in which case he might have received a finder’s fee.

Bonner’s personal acquaintance with members of the financial press,acquired as financial editor of the Miami Herald prior to his joiningGeneral Development Corp., also proved to be of value in implement-ing the company’s public relations program. In November 1961,learning that an old friend who was financial editor of a metropolitandaily newspaper had arrived in Florida to attend a meeting of theInvestment Bankers Association, Bonner invited him to come toMiami to talk to company officials. The financial editor and his wifesubsequently spent 2 days as guests of the company, and the followingmonth he wrote an extremely favorable article about the company’sprospects in his newspaper.

Bonner testified that in another instance a syndicated financial col-u.mnist, with whom he was friendly, agreed to write an article refer-ring to General Development Corp., upon the promise of obtaining"the beat" on the results of a study of the effects of the Government’sApollo program on the economic prospects for Florida, which hadbeen sponsored by several Florida companies, including General De-velopment Corp. The column, when it appeared, included favorablementions of the company.

Personal contacts also play an important part in the placement ofpublic-relations releases. One practitioner testified that he was in-strumental in obtaining an allocation of a "hot" issue for a memberof the financial press: a few months later he was able to "place" ana.rticle concerning a client with the journalist. TM It is not uncommonfor financial public-relations men to distribute releases by h~nd orthrough an intermediary who is personally acquainted with a memberof the financial press or a s~curity analyst. Wyle Associates, Inc., aNew York public-relations firm, was retained by General Develop-ment Corp., principally for the purpose of liaison with the financialpress. News releases which the company wanted distributed in NewYork City were prepared by company employees in Florida and mailedto Wyle in New York where they were mimeographed and distributed,often personally by Wyle, who had close personal contacts with mem-bers of the financial press.135

Some financial public-relations men make a practice of telephoningor personally calling on members of b.rokerage houses in order to createinterest in the securities of their clients. According to one publicrelations man, the technique isleak out a little ne~vs here, to talk ~vith their friends and compatriots in WallStreet, to tell them that this deal * * * was coming up. * * *

You call up your friends, tell them you have a hot tip. There are alwayscustomers, men in each company who are the hot tip boys ; they are the aggressiv~boys. You know who they are; anybody in the business does. If you don’t,why, you find out.

nancial writers of New York~s~ The underwriter concerned allotted new issues to ~ . fourCity daily newspapers in 1961. For a discussion of allocations of new issues to pub-licists and financial journalists, see ch. IV.B~.3.b(3) (b),.

~ In a letter to General Development written prior to his reten¢i(~n Wyle .state4 : "[Our]press contacts are close, not only in New York but throughout the country." He alsopromised that he would [d]evelop--when the time is ripe---closer liaison with financialanalysts."

REPORT OF SPECIAL STUDY OF SECURITIES lVIARKETS 83

These practitioners are creators of rumors of mergers, stock splits,management changes, or other corporate news that might affect marketprices of securities. 13G Because they operate by word of mouth, theiractivities are difficult to document or control. Evidence has been foundof one public relations man who maintained close contact with severalregistered representatives ~t large brokerage houses, ma.ny of whosecustomers had extensive trading in securities of compames in whichthe public relations man had a financial interest. The pattern seemsto be that when the public relations man wished to create demandfor a security, he would call his brokerage connections--in some casesby means of a private w.ire which he had installed--and give themsome favorable corporate news that was not yet public or would merelysay that he and his associates were planning to buy large amounts ofthe company’s stock. The registered representatives would relay theinformation to their customers and recommend that they purchase thestock. They would also purchase the stock for their own accountsand for accounts over which they had discretion.

The placement of articles in the financial press appears to be animportant technique of the industry, and many clients expect place-ments as the natural outcome of their retention of a financial publicrelations firm. For example, one public relations firm wrote to a newclient:

A comprehensive publicity program will bo carried out in all business andfinancial mediums * * * This will result in placements in the Wall StreetJournal, Barron’s Weekly, Dow-Jones wire service, the Associated and UnitedPress wire services, as well as other financial publications much too numerousto mention.

Some companies contract with publ.ic relations firms for specific num-ber of placements. One company wrote to a firm it had just retained :

After investigating the public relations field it appears to us that during thefirst year you should be able to accomplish a minimum of the following place-ments of infornm~tion before the public : At least four r6sum(~s of the accomplish-ments of our company and one picture in the major newspapers * * *

Placement of public relations material in investment advisory publi-cations, though not unknown, seems to be less common than in the caseof the financial press.137

.Luncheon meetings with groups of analysts play an Important part

in many public relations programs. These meetings, at which corpo-rate officials address the analysts, have become an established part ofthe financial scene. The principal such group is the New York Societyof Security Analysts, which has P~,800 members, most of whom areanalysts with financial institutions such as brokerage houses, banks,and mutual funds. To become a member a person must have beena security analyst for 5 (in certain cases, 3) years and must be regularly

¯" " " " 138engaged as an analyst at the t~me of admission to membership.

There is no requirement that a member continue working as a securityanalyst in order to retain his membership and there are at least 17financial public relations men, representing some of the principalfirms, who are members of the society23~

~Address of Weston Smith to Publicity Club of Boston, Apr. 4, 1962 (reprinted inCommercial and Financial Chronicle, May 3, 1962, p. 25).

a~ See pp. 81-82, above.~as Constitution of the NYSSA, art. III, sec. 1.xa~ 1962 Membership Directory of the Financial Analysts Federation.

84 REPORT OF SPECIAL STUDY OF SECURITIES lVI_ARKETS

Four or five times a week the society invites representatives ofcorporations to address its luncheon meetings, which are attended byan average of approximately 150 members. A financial public rela-tions firm will normally try to arrange an appearance before thesociety for each of his clients as often as permitted.14° The societylimits the frequency of appearances by any one company to one every2 years and it ~ttempts to restrict such appearances to companies inwhich there is a substantial public interest. In general, the societyregards companies with annual sales of less than $50 million or a float-ing supply of less than 600,000 shares as too small to warrant an invita-tion. There have been many exceptions made, however, to this policy.

Luncheon meetings of the socmty have frequently been used bycompanies as a vehicle to g~in corporate publicity. New product de-velopments, projections of earnings, and other items of corporate newsare often revealed on these occasions. For example, BarChris Con-struction Corp.,. General Development Corp., the Lionel Corp, ~ndAvnet Electromcs Corp. used meetings of the society to make suchannouncements, all of which were extremely optimistic. : Informationwhich is released in this manner is likely to receive wide dissemina-tion, since meetings of the society are often covered by the financialpress. Press coverage of meetings is exemplified in the case of a meet-ing addressed by the president of General Development Corp. on Oc-tober 10, 1961. The speech was reported prominently on the financialpages of newspapers throughout the country and in all six regionaleditions of the Wall Street Journal. Some brokerage firms m~ke ita practice to print a condensed version of such speeches in their marketletters, while others send a report on addresses to the society over theirwires to branch offices. 141 Public relations firms often arrange toprint up their clients’ speeches and send them to the stockholders andto the full membership of the society. The results of one company’saddress in terms of publicity were reported as follows:

There was good publicity in all major financial centers and in trade magazines.Investment firms have shown ~ greater interest in obtaining information aboutthe company and at least two have prepared circulars recommending [the com-pany’s] stock. An increased public interest in [the company’s shares] has madeit easier for the company to pursue its plan of acquiring other properties.1~

Similar but smaller analysts’ groups in major cities outside NewYork City also invite officers of publicly held companies to addresstheir meetings. In addition, groups of analysts specializing in par-t]cular industries have been formed; these relatively informal luncheongroups, each consisting of about 30 to 40 analysts, meet on a more orless regular basis for the same general purpose.

Besides getting their clients before these organized groups ofanalysts, public relations firms often arrange "hosted luncheons" towhich a selected group of security analysts as well as members of thefinancial press are invited to listen to the president or other officer of

1~o Of the 46 issuers who received questionnaires concerning public relations activities,representatives of 15 addressed the New Yo.rk Society of Security Analysts between Jan-uary 1960 and March 19.62.

14~ The General Development speech was the subject of reports by Francis I. DuPont &Co., Shearson, Hammill & Co., Thomson & McKinnon, and Walston & Co., and a privatewiro of Bache& Co. A speech by the president of Avnet Electronics Corp. to the societyon Mar. 16, 1961, was reported by Merrill Lynch. Pierce, Fenner & Smith in a wire flashto all branches, by Francis I. DuPont & Co. and Newburger, Loeb & Co. in market letters,and by H. Hent~. & Co. in a morning wire.

~ Public Relations News, Nov. 6, 1961, p. 4.

REPORT OF SPECIAL STUDY OF SECURITIES 1VaARKETS 85

the client tell his corporation’s "story." Unlike the luncheons of or-ganized groups, these meetings are paid for by the company that wantsto be heard.14~ Hosted luncheons are sometimes sponsored by under-writing firms on behalf of issuers subsequent to the co~npletion ofofferings. According to one partner in an underwriting firm, this isdone in order to fulfill the underwriter’s responsibility to keep the in-vesting public informed of the progress of the company.144 Suchmeeti,n.gs were arranged by underwriters for Avnet Electronics Corp.,BarCl~ris Construction Corp., and Chemtree Corp. The effectivenessof thes~ meetings as a means of persuasion is perhaps open to question.According to members of the financial community and the financialpublic relations industry, anal.ysts are too sophisticated to be taken inby a sales pitch. One partner in a brokerage firm says of the analysts,"they have been around a long time, and as the saying goes, they havebeen pitched to by experts." Yet the fact that many companies con-tinue to solicit invitations from analysts’ groups and invite analysts tohosted luncheons tends to confirm their efficiency as a method of ob-taining publicity or favorable mention in investment advisory ma-terial. One drug company announced its marketing of an importantnew drug for the treatanent of diabetes, not to a gathering of physi-cians or pharmacists, but to an invited group of investment bankers,security dealers, brokers, and analysts at the Bankers Club. The an-nouncement coincided with the listing of the company’s common stockon the New York Stock Exchange.

Entertainment is considered an important part of financial publicrelations. Security analysts and members of the financial press are"deluged" by invitations from publicly held corporations or their pub-lic relations men to attend cocktail parties, exhibits or new products,"junkets," and other such events. A junket, which one public rela-tions man has described as a "standard publicity procedure," is a tripby a group of analysts to visit a plant or other property of a company.Junkets are sometimes employed to introduce to the financial com-munity a new product which has not yet been revealed to the pul~lic.All expenses, including transportation, hotel rooms, and meals, arepaid for by the company. Some companies have expended substantialsums upon junkets; for example, General Development spent nearly$10,000 for such purposes during 1961. Junkets, however, serve thepurpose of giving analysts an opportunity to visit a factory and meetmembers of company manage_anent, thus enabling them to make a bet-ter informed judgment concerning the company. Nevertheless, somecompanies apparently have used junkets principally as a method ofentertaining analysts and financial writers. It is ,noteworthy thatFlorida land development corporations, which ha~e the advantage.of being able to offer their guests sunshine and other advantages of aresort, have been leaders in organizing junkets. Lefcourt RealtyCorp. brought 35 analysts to Florida from New York City in thespring of 1960 at a cost-qf approximately $10,000. The junket wasdescribed as follows by u p~iblicity man who was then working for thecompany :- They were flown d(~wn, came into RoyaI Palm Beach, where we gave them

description and a little expIanation of the Palm Beach properties, and why we

x~a An editor of Financial World magazine testified that he attends such luncheons on anaverage of one a month.~,4 See Business Week magazine, Sept. 24, 1962, p. 152.

86 REPORT OF SPECIAL STUDY OF SECURITIES ~YIARKETS

felt the area would grow, and the profit potential, and so forth, and entertainedthem with Virginia Gentleman whisky. And then, Saturday, we too.k them bybus to Miami where they toured Carroll City and then went to the DiplomatHotel * * * Sunday, we took them by bus to Gape Florida and put them onthe plane that afternoon, but the plane di4 not go so we had to enterta,in themthat night, and they left late Monday.

But this is standard procedure; everybody does it. The only co~nplaint thatI heard from the analysts was that they did not get any information. [The pres-ident of the company] was a gracious host, but didn’t talk about finance and[the treasurer] was asked not to appear. * * * Offhand, I would say it was avery pleasant weekend.

Gulf American Land Corp., another Florida land development com-pany, on the suggestion of its financial public relations man, brought42 analysts to its property at Cape Coral during 1961. General Devel-opment Corp. conducted a junket for more than 40 analysts and mem-bers of the financial press in 1958. In 1961 this company invited 21analysts in 2 groups to visit its Florida properties. Each of the 1961trips lasted 4 days and included tours of the company’s principal realestate developments as well as interviews with officials of the company.The trips also included a day at a country club owned by the company~where there was an opportunity for gol~ swimming, and other formsof relaxation. The analysts who participated were advised to bringtheir golf shoes--the company promised to supply the other equip-ment. Of the 18 brokerage houses represented on these junkets~ 5issued market letters favorable to the company within 3 months ofthe visits~ and 6 others indicated approval in internal communications.In addition, an investment advisory service recommended the stock,and a large foundation which was represented on the trip purchaseda large block of convertible debentures.

Security analysts and members of the financial press who have par-ticipated in such junkets almost invariably say that they could notpossibly be "bought" for a free meal or a night’s lodging. Neverthe-less, it cannot be denied that "entertainment," especially in its morelavish aspects, constitutes a problem. To give a group of analysts afree vacation, complete with country clubs and parties but with littlebusiness activity, would seem to cross the line of propriety. The needis clear for more rigorous supervision by employers of the analysts andwriters, and for a keener awareness of the-inherent ethical problemson the part of issuers and also of the firms and publications furnishingthe purportedly objective financial analysis and news upon whichmembers of the public may base their investment decisions.

Not all pu’blic relations programs include entertainment of analystsor similar activities. Many companies, being primarily interested inmaking full disclosure of corporate information rather than in per-suading the financial community of the desirability of purchasing theirsecurities~ confine their public relations efforts to sending regular re-ports to stockholders and issuing accurate press releases when justifiedby corporate development. But it is also apparent, even though thepresent inquiry is based on a small sample, that the methods of thepress agent and the huckster are being used in the dissemination ofinformation concerning some publicly held companies.

5. CONTENT OF CORPORAT]D PUBLICITY

The ultimate test of corporate publicity is its accuracy. To theextent that it is inaccurate or overoptimistic~ the fault is in large part

REPORT OF SPECIAL STUDY OF SECURITIES I~¢IARKETS 87

attributable to the fact that the financial public relations man is notonly a distributor of corporate information but also a kind of pro-moter. Some financial publicists even say that it is permissible to slantthe truth in the interest of a client. One practitioner has expressedthis point of view as follows:

When you were wooing your wife, you told her she was the most beautiful girlin the world and she wasn’t, but you thought she was. * * * [This] is the samething, * * * I don’t think you have got to tell the cold factual truth every time,what the ur~biased civic minded would call the truth.

On the other hands many public relations men will try to stick close tothe truth. According to one financial editor s "they know they canfool a newspaper just once and never get another chance."

Financial public relations men generally refuse to accept responsi-bility for the accuracy of publicity which they distribute. 1.5 Theirposition is thats since there is no practical way for them to check mostcorporate factss they have a right to assume that information givento them by their clients is true. However justified this attitude maybe, it has led some brokers to distrust, any material that is,not receiveddirectly from responsible cor,p, orate officials. The research partner atSutro Bros. & Co. put it this ~ ay : ’

[A] public relations firm, * * * can be hired and fired at will, and, if somethinggoes wrong, I have no one to go to and try to straighten the situation out.Obviously the public relations concern that was hired by some company andno longer represents them has tittle interest in the matter. * * * It is just toobad and I have no one to turn to. * * *

¯ * * [The] written information I receive from p~blic relati(~o’s firms, I tendto pay relatively little attention to it. The only time * * * a public relationsfirm can be helpful is when I want to get on the phone or esta~l.ish a contact witha company personally.

¯ * * [W]hen things don’t go well, there is a certain quietness and you don’thear very much from them.

Some members of the financial community take a somewhat cynicalattitude toward the reliability of corporate publicity~ even when itcomes directly from an officer of a corporation. For example, a part-ner of Goldman, Sachs & Co. has remarked that "it just does not makesense" for any substantial investor to "care one was or the other" aboutwhat a company’s officials tell meeting of security analysts. Othermembers of the financial community have expressed similar senti-ments. An investment adviser has informed the Commission that heis "appalled" by the erroneous financial information supplied by com-pany officials. A member of the research department of HemphillsNoyes & Co. has testified:

My feeling is that a public relations man, working for a company, has an ax togrind and, therefore, the chances are you are not going to get anything of realuse from him. You are going to get a slanted picture.

It is sometimes difficult to draw a sharp line between misleadingpublicity and publicity which me~ely puts a company in the best possi-ble light that is still consistent ~ ith the truth. The public relationsman considers it his duty to create a favorable imp.ression of hisclienrs. According to one practitioner~ "* * * primarily, you are try-ing to communicate the good things~ the newsworthy things about

x~ One public relations man stated: "At no time do we take the responsibility for anyclient. This Is standard procedure in every public relations organization, whether it beproduct publicity, financial publicity, or governmental publicity. This procedure is stand-ard all over the United States."

88 REPORT OF SPECIAL STUDY OF SECURITIES lVIARKETS

your company to the people who are either stockholders or you hopewill be stockholders. In speaking of regular financial reports tostockholders, another public relations man had this to say :

If you run into a year when things are pretty bad, you have got to keep going.Norm’ally, you don’t use an unfavorable fact as an opening. But you ke~p ongoing, sending out the letters, and you report "the second quarter is down froma year ago." There is no question that you would get the facts in, but theywould be sort of backward.

The corporate publicity examined in the course of this study ~anthe gamut from straightforward reporting of corporate affairs towhat can only be described as deliberate attempts to falsify a com-]?any~s financial condition or prospects. Only rarely, however, wasInformation disseminated which was a complete fabrication. Mis-"leading. . publicit, y usually consists of optimistic. . sales, and earnings. .projections which seem to be based pmmamly on w~shful thinking,glowing descriptions of new products which are still in the exper~-mental stage, and announcements of mergers or acquisitions which areonly vague possibilities.

A clear example of inaccurate and irresponsible corporate publicitywas that distri’buted on behalf of BarChms Construction Corp. by itsfinancial public relations firm, Samuel Weiss & Associates, Inc. FromAugust to December 1960~ Weiss distributed publicity to the invest-ment community concerning the ~lleged. expansion of the company’sbowling alley construction operations in England~ Italy~ and otherEuropean countries. In August 1960~ the company reported that ithad "completed negotiations" for a contract to construct a 39.-lanebowling center near London. Negotiations for such a contract ap-parently did take place, but no contract was concluded and BarChrisnever constructed any bowling all.eys in England. On December 30~1960, Leonard Russo, executive wce president of the company, tolda luncheon meeting of the New York Society of Security Analyststhat a bowling center was planned in London and also stated that:

We already have a 24-lane bowling center under construction in l~me. * * *We expect to have bowling lanes in every major Italian city.

Over 1,000 copies of this speech were distributed to brokerage housesand others in the financial community. In its annual report for theyear ending December 31~ 1960, which was dated March 10~ 1961,the company stated :

In 1960 BarChris moved aggressively into the European market by signing acontract for a peerless modern 24-lane bowling center in Rome, Italy, thefirst of several to be built in other major Italian cities. In Belguim, France,the Netherlands and Great Britain negotiations and site selections were begunfor other BarChris installations.

5[o construction was ever begun by BarChris or any company undercontract, with BarChris on any bowling center in Rome or any otherEuropean city~ although a lease was signed and plans were drawnfor the proposed Rome center. Despite its publicity concerning Euro-pean operations during 1960 and 1961, BarChris never achieved anyearnings from any such operations.

BarChris’ announcements concerning its 1961 financial results wereequally inaccurate. In 1960 the company shared in the p~osperitythat the bowling industry was then enjoying, achieving sales of$9,165,000 and net income of $868,000 ; this was by far BarChris’ most

REPORT OF SPECIAL STUDY OF SECURITIES ]gIARKETS 89

successful year. In his December 30, 1960, speech to the analysts’society, RuSSOmi~lionredicted, "on the basis of orders alreadyreceived,"sales of $15 and earnings of $1,200,000 in 1961. -During thefirst 6 months of 1961, the investing l~ublic and the company’s stock-holders were given no reason to believe that these est~nates wouldnot be realized. In a letter to stockholders dated June 20, 1961, thecompany stated: "Sales and earnings are running well ahead of lastyear." A month later, the company reported that its sales were$4=,137,000 and its net income $.357,000 for the first 6 months of the year;these figures represented increases, respectively, of 30 and 50 percentover the same period of 1960. Two weeks later, however, the com-pany revised the 6-month income figure downward to $237,000, .ex-plaining that it had decided to set up a reserve to cover possible lossesarising from the bankruptcy of one of its customers. Despite thissetback the company stated flatly, in a "report to the financial com-munity" which was sent to stockholders in August 1961, that itssales "will approximate $10 million this year," and that "earningswill exceed the 75 cents per share recorded in 1960.146

On O¢~ber 31, 1961, in a release that was sent to 800 members ofthe business and financial press, security analysts, and other membersof the investment community, BarChris announced sales of $7,085,000and earnings of $716,000 for the first 9 months of 1961. The estimatesfor the full year that had been made in August were reiterated, exceptthat the earnings estimate was increased to $1,200,000, or $1 pe~ share.On November 22, 1961, the company announced the declaration of a4-percent stock dividend, which was said to be "based on the new highrecords in sales and earnings anticipated by BarChris for the yearending December 31, 1961." As late as March 20, 1962, the companyreported to the Wall Street Journal that its 1961 sales totaled$9,500,000 and net income $400,000.

It was not until April 6, 1962, that BarChris issued .an au~lited finan-cial report for the year 1961. This repor~ showed that the company’snet sales for the entire ~ear amounted not to $15 million or $10 million,but only $5,075,000, and that its net earnings amounted not to $1,200,-"000 or $400,000, but only $51,000 which included a special nonrecurringgain 9f $206,000. Thus the company actually sustained an oper-ating loss of $155,000 for the year. The company explained that thepreliminary, figures for 1961 which had been reported did not take intoaccount various final adjustments which had to be made to reflect thefact that several customers for whom.BarChris had constructed orwas constructing bowling alleys defaulted on their contracts. Sincecompany management learned of these defaults during 1961, the opti-mistic predictions made in late 1961 and early 1962 seem inde-fensible.1.7

Other BarChris publicity was equaliy inaccurate. On August 11,1960, the company announced, in a report that was sent to 2,175 se-curity analysts and members of the press and 1,300 stockholders, that"BarChris has begun construction of an 80,000 square foot manufac-turing plant near Valley. Stream, Long Island," which was scheduledfor completion in the spr~ng of 1961. This information was incorrect.

X~Thls rel~o.rt was the only one of ]~rChris’ pu, bllctty releases referred to in thissection which was not prepared and distributed by Samuel Weiss & Associates, Inc.1~7 On Oct. 29, 1962, BarChris filed a petition in U.S. district court for reorganizationunder ch. XI of the Bankruptcy Act.

96746 O--63--pt. 3--7

90 REPORT OF SPECIAL STUDY OF SECURITIES I~_ARKETS

Construction was never begun on a plant at this site~ because the NewYork Building Department never approved the plans submitted; asmaller plant, however, was later built on another site on Long Island.

The provisions of the Exchange Act requiring listed companies andcertain unlisted companies to file periodic reports are not always proofagainst the dissemination of misleading informal publicity on thesame subjects as those covered by the official reports. These provi-sions do not prevent companies from sending their stockholders finan-cial statements inconsistent with--and much more favorable than--the statements for the same periods filed with the Commission. Astriking example of such a practico which was recently exposed bythe Commission involved Atlantic Research Corp., whose stock islisted on the American Stock Exchange. This company, which hasseveral subsidiaries, in May 1962 filed with the Commission and theAmerican Stock Exchange its required annual .report for the year1961, containing consolidated financial star, mental which showed a netloss of $1,066,015. The annual report for 1961 which the companysent to its stockholders, however, contained unconsolidated financialstatements and these showed.net income of $1,473,192.1.*

Projections of sales ~nd earnings are of great interest to securityanalysts. One analyst stated : -

I can’t imagine any group of analysts being together with company officialsand not asking [for earnings predictions]. That would be one of the first ques-tions we would ask * * *

The New York Society of Security Analysts encourages publiclyheld companies to make financial predictions. A recen~ publicationof the society expressed this view:

What does the Security Analyst expect from a company.

3. The heart of security analysis is the forecast. ’M,anagement’~ forecast, basedupon sound planning can be of great help to the analyst. ,While there are ex-ceptions it is generally true that the more astute the management the moreaccurate the forecast. Overoptimistic and overpessimistic forecasts are equallyharm$-ul to the company, the analyst, and the stockholders. The company isjustified in not giving current figures to analysts prior to general publication butit can be helpful to the company and the analyst if the trend of current earn-ings is discussed,a**

Perhaps because of some innate characteristic of human nature,estimates of financial results tend to err on the side of optimism.Moreover, it is very difficult for new companies in new types of busi-ness to make accurate predictions. In the case of General Develop-ment Corp., for example, John Bonner has stated:

It is almost impossi’ble, because of the nature of the business, to make anaccurate prediction some months in advance.

John L. Weinberg, a partner of Goldman, Sachs & Co. and a di-rector of General Development, has expressed a similar opinion:

¯ * * I have always said I believe making predictions o~ earnings for GeneralDevelopment is a mistake on the record, and everybody on the board knows Ifeel that way, because their predictions * * * ’have not been accura.te. I{ youcan predict it like a utili.ty, all right.

l~s See Securities Exchange Act release No. 6911 (Oct. 10, 1962). For a discussion other aspects of the Atlantic Rvsearch case, see pt. D of ch. III.

X*gBulletln on "Corporate Relation§," published by New York Society of SecurityAnalysts, p. 4.

REPORT OF SPECIAL STUDY OF SECURITIES I~L~RKETS

Despite these misgivings of two of its officials, General Developmentgave security analysts and the press estimates of 1961 earnings thatturned out to be far too optimistic. In March and April 1961, thecompany was making estimates of earnings of $1.40 per share for theyear en~ling December 31, 1961, to security analysts who interviewedcorporate officials. According to an analyst with Standard & Poor’s,however, Bonner told him confidentially in May 1961 that the 1961earnings @ould be "close to $2 a share." In September 1961, thecompany’s chairman of the board repeated the $1.40 prediction in aspeech to a group of analysts and in October the president of GeneralDevelopment told the New York Society bf Security Analysts thatearnings would be between $1.20 and $1.40.1~° Actual earnings, an-nounced i~. March 1962, were $1.05 per share.

In September 1961, Specialty Electronics Development Corp., anover-the-counter issuer which manufactured communication equip-ment for the Armed Forces, distribu.~ed t.o analysts’ and financialwriters a brochure which gave estimated earnings of $100,000 for theyear which had ended on July 31, 1961. Actual earnings proved to beonly $65,000. In the same brochure, sales of $8 million were predictedfor fiscal 1962. For the first half of fiscal 1962 the company’s salestotaled approximately $1,500,000 and the company suffered a net lossof approximately $85,000. In March 1962 the company’s stockholders,who until that time had received only good news from the companyand i~s public relations firm, learned that a petition for an arrangementof creditors had been filed under the Bankruptcy Act.

Several other companies whose publicity was examined in the courseof this study gave sales and earnings estimates that turned out tobe substantially too high. In a release dated February 14, 1961,Grayson-Robinson Stores, Inc., a company listed on the New YorkStock Exchange, predicted that sales for the year ending July 31,.1961, would amount to more than $100 million. The actual figurewas $77;354,000.1~1 On September 20, 1960, the president of UniversalControls, Inc.~ stated that he was "confident" that earnings for they.ear ending March 31, 1961, would exceed the $4,174,000 of the pre-vious fiscal year; he repeated the statement a month later, saying:

This year I can predict that we will again establish even higher levelsof sales, earnings, and progressive growth of development. * * *

On June 12, 1961, the company informed its stockholders that earn-ings for fiscal 1961 had actually amounted to approximately $1,900,000.

Even if the corporate officials or publicists who were responsible forthe projections can show that they made them in good faith, theseexamples demonstrate the necessity of caution and restraint in givingfinancial estimates--as well as in evaluating them.

Overenthusiastic or premature publicity concerning product devel-opments constitutes another potential abuse. In May 1960, FairbanksWhitney Corp. announced at a stockholders~ meeting that it had beenengaged for several months in the development of a low-cost processfor desalting sea water. Three months later, the company reportedthat a commercial desalinization plant was under construction in

~°’See the Wall Street Journal, Oct. 11, 1961, and July 3, 1962.

of ~reOd~’toAr~:d4~r lc9h6.~IG:~" ~l~n~Ra~bk~S~t~ySAt%~.e- "s, Inc., filed a petition for an arrangement

92 REPORT OF ~PECIAL STUDY OF SECURITIES I~IARKETS

Israel and was "due to go into operation after the 1961 midyear."In a release dated January 12, 1961, the company announced com-

pletion of the first mass-production unit, and promised that plansor worldwide marketing of its process would be announced in March

1961. Full operation of the plant in Israel was predicted by early1962. These releases received wide publicity, which included articlesin Fortune, 1~2 Look,15~ Newsweek,TM as well as in the Wall StreetJournal ~ and other newspapers, and the company was mentionedin advisory material published by Merrill Lynch, Pierce, Fenner &Smith, Hayden Stone & Co., Inc., E. F. Hutton & Co., and A. M.Kidder & Co., Inc.

By the spring of 1962, the plant was not yet in operation, and noplans for worldwide marketing had yet been announced. The 1961annual report, published in early 1962, gave "technical delays" as thereason for the absence of results. It stated that the engineers hadasked for more time to increase the efficiency of the unit and cited thenewness of the components and the climatic conditions in Israel.

Another example concerns the Lionel Corp. On December 9, 1960,Gen. John B. Medaris, its president, told a meeting of the New YorkSociety of Security Analysts that Lionel had developed a currency-sensing machine capable of identifying bills from $1 to $100, which"today is in the most advanced state of perfection." Medaris saidthat the company was "now beginning marketing discussions lookingto the marketing of this product" and that it would be in productionwithin a short time. Ten months later, however, the company reportedin a proxy statement filed with the Commission:

This company recently designed and developed a currency recognizing device,several prototype models of which have been built up to this time. The devicehas not yet been marketed and there is no assurance at this time as to whetherit will be a profitable item.

The deliberate withholding of news by companies can be as harm-ful to investors as the release of inaccurate or overoptimistic news.On the day before General Medaris’ speech, rumors that Lionel wasentering the currency-sensing field reportedly were circulating onWall Street and helped push the price of the stock from 28 to 30 ona volume of 64,000 shares. ~ (On the day of the speech the stockdeclined to 293~ on a volume of 50,000 shares.) Such incidents havecaused the New York Stock Exchange to require listed companies torelease immediately any corporate information which might affect theprice of their securities.157

Sperry Rand Corp., a company listed on the New York Stock Ex-change, flew 37 members of the press and security analysts to its Univacfacilities in St. Paul, Minn., on December 6, 1960, for an exhibitionof new products which according to the company constituted a "break-through"-in the field of electronic data processing. The news of thesedevelopments was not scheduled for general release until December 15,1960. The withholding of this publicity from the public, after itsrelease to a few interested persons, caused a flurry of rumors and ab-normal trading action in the company’s stock. On December 8, 1960,it rose to 23~ on a volume of 143,700 shares. On December 9, at the

June 1961.July 19, 1960.Feb. 1~, 1961.Mar. 31 and Apr. 4, 1961.The Wall Street Journal, Dec. 9, 1960, p. 25.See sec. 6, below.

REPORT OF SPECIAL STUDY OF SECURITIES ~IARKETS 93

urging of the New" York Stock Exchange, the company made theannouncement which had been scheduled for December 15.

It must be recognized, of course, that the line between prematurepublicity of an event that may not come to pass and withheld publicityabout events known to insiders is not easy to draw in practice. Theredoes not seem to be any general agreement, for example, on the precisestage of merger negotiations at which it is appropriate to issue arelease. Obviously, publicity about a prospective merger that isnothing more than a gleam in the management’s eyes is totally un-warranted. The prevailing corporate practice seems to be to announcea merger as soon as the directors have taken any action toward it.Many public relations men seem to agree, however, that if rumors ofa corporate development begin-, the company should immediately re-]ease word of its exact status. The New York Stock Exchange policyof prompt disclosure appears 15s to have had a significant effect ininducing listed companies to release information rather than to holdit for release at some "convenient" time.

6. CO~TTROLS OVER CORPORATE 1)UBLICITY

The above report on existing practices surrounding corporations’financial publicity reveals problems which, for the most part, aresubtle in nature even though the abuses may be gross in particularsituations. Existing regulation in this field is relatively limited, atleast as compared to that in other kinds of activity affecting the se-curities markets. Federal law is in the main not concerned with "un-official" corporate publicity. Regulation as a whole--by all authori-ties, official and unofficial leaves untouched some of the problems thathave been revealed, and reaches others only indirectly, by such meansas control over the use of publicity in connection with new issues;general provisions against fraud, manipulation, and commercial brib-ery ; and, with respect to some issuers only, provisions of the ExchangeAct as supplemented by the rules and policies of some of the exchangesand the NASD requiring periodic filing of data, regular reporting tostockholders, and prompt public disclosure of financially significantdevelopments.

The Securities Act, establishing procedures by which "selling" in-formation concerning public offerings of securities may be dissemi-nated to the public, sharply restricts the use of public relations im-mediately before the offering. No offer may be made, of course, beforethe filing of a registration statement. During the interval betweenfiling and effective date of a registration statement, no written com-munication offering the security may be used except an identifyingstatement or a prospectus, which must contain information specifiedby the statute and rules. After the effective date, sales literature otherthan a prospectus may be used, but only if preceded or accompaniedby a prospectus. The prospectus requirements remain in effect as longas the offering continues and, for dealers selling registered securities,at ]east during the 40-day period following the effective date or thecommencement of the public offering.

Despite these strict rules, a number of cases have come to the atten-tion of the Commission in which planned publicity seemed clearlydesigned to condition the market in connection with a stock offering.159The Commission has pointed out that the use of public relations at a

l~s See sec. 6, below.tr~ See In the Matter o] First Maine Corporation, 38 S.lg.C’. 882 (1959).

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44 report of. special study of securities...

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